Know the incentives of those selling you a financial product

“There is no such thing as a free lunch.” You may have heard this famous quote emphasizing the idea that you cannot get something for nothing. This is particularly true when it comes to selling financial products. People could have an agenda and/or an incentive to sell or not to sell a particular financial product to you.

In this story, I want to narrate a story to explain how misaligned incentives nudge people to sell financial products that investors are not looking for or those that may not be a right fit.

This is a mutual fund buying experience of my neighbour. Let’s say her name is Sunita.  

Sunita, a 40-year-old woman in a tier-2 city, wanted to invest in mutual funds for the first time.

Sunita had been hearing about MFs for some time and that it is a good long-term product to earn better returns. She went to a nearby bank to enquire about the product.

If you are someone who invested in mutual funds through a mobile app in the comfort of your home, you must be wondering why Sunita had to go to a bank. Remember, for most people from tier 2 & 3 cities, a bank is the only trusted place to know about financial investments.

The bank manager started selling a life insurance product to Sunita. It is that savings-linked insurance product that promises to return your premiums with some return along with a life cover. Read more about these insurance products here.

Confused about the suggestion, Sunita returned home, did some research, and decided to invest in mutual funds only.

She went back to the bank. The manager started pushing the insurance product again. When Sunita interrupted to express her disinterest in insurance, the manager frowned instantly.

Here comes the first question – why does the manager want to sell an insurance product to Sunita when she wants to save in mutual funds?

The commission one can earn on selling insurance products is much higher than selling a mutual fund. The commission on selling mutual funds (regular) ranges between 0.1%- 2% of the value of your investment and remains the same throughout the investment tenure. On the other hand, in most cases, the insurance agents get a hefty percentage of the premium in the first year of selling, which eventually drops from the second year onwards. The higher commission structure for insurance would lead some financial product sellers to push this over mutual funds.

Note that insurance is not a bad product. Ideally, everyone should have term insurance (not a money-back policy) and health insurance. Also, this is not to paint everyone with the same brush. There are some bad apples out there, and you must be careful not to get one.

Back to the story, when Sunita insisted on investing in mutual funds, the bank manager proposed active funds. When asked about low-cost index funds, the response is that they are not available to invest.

Ideally, the process of investing in passive funds shouldn’t be any different from investing in active funds. If a seller desists you from investing in the former, ask why.

If the response is not satisfying, there could be a chance that passive funds are not preferred because of their low commission structure compared to active funds.

After much back and forth, the bank manager finally found a way for Sunita to invest in index funds. However, the processing time for investing in these funds took two days longer.

This story of Sunita highlights why it is important to know the incentives of a person selling you a financial product. Inquire about how they earn through the sale. It might feel awkward, especially if the person is someone you know. However, keep in mind that transparency is crucial in all financial transactions.

Remember, receiving a commission isn’t inherently negative, but staying informed about their incentives helps us remain cautious if someone attempts to influence our decisions.

There’s no such thing as a free lunch. Even if you’re paying for it, it is your responsibility to select the place that provides the food you like and that satisfies your hunger.