In another avatar, I am part of a panel that provides free financial advisory services. Over the past nine months, we have studied several thousand portfolios. The payoff for us is that it gives insight into the way middle-class individuals structure their financial lives.
The population is skewed - only somebody who has bothered to think about his/ her financial health will bother to access us. So it may be assumed that anybody who shares information with us is already evolved beyond the norm. The demographic profile suggests the service is popular with urban professionals who have a fairly high savings rate (40 per cent plus is normal) and assets across various classes.
Some broad themes show up again and again. The effect of the EMI-driven housing boom is most apparent. Almost everyone has a finger in the housing pie and that holds overwhelming portfolio share. Some have been smart enough to fix their rates at 2004 or 2005 levels (between 7.5 per cent and 8.5 per cent). Others have had to reorganise their lives to cope with rising EMIs and longer repayment periods. This is often the trigger that leads them to us.
The second theme is that equity investment is haphazard. The IT professionals tend to have concentrated holdings in the companies that feature on their resumé due to ESOPs. Other equity investors hold anywhere between 3 and 45 stocks, with a large majority being IPO punters rather than secondary market players. There is rarely a hint of scientific diversification - companies are scattered across various industries.
Some have a combination of equity mutual funds (up to 42 in one instance!) ranging between NFOs, old standards and specialities. Again these seem to be haphazard selections. Most good funds have very similar portfolios - so buying the top five diversified mutuals will only expand holdings of the same 30-odd stocks.
Among the debt investors, very few actually hold debt mutual funds at all. Most prefer fixed deposits. The only reason I can think of is that a debt investor is unhappy at the thought that his asset value declines when rates rise. Of course, the last three years have seen a bear market in bonds so this may actually be a sign of sanity.
The most ubiquitous error however, is in terms of insurance coverage. In the course of studying some 200-odd portfolios, I have not yet come across one that had what could be termed efficient insurance cover.
Almost nobody (this includes insurance professionals) holds term plans. Some hold old-style money-back policies. Most hold new-style unit linked insurance plans. Very few have adequate health insurance but this could be a function of being employed since most corporates offer health coverage that extends to families.
ULIPs have of course, been sold without fear or favour, by every agent in the past few years. This is not surprising because the ULIP allocation structure leads to massive initial commissions. Most people buy it out of ignorance and quite a few are all set to churn the instant they cross the mandatory lock-in.
This is a great pity. If you hold a ULIP long enough, the returns will probably compare to a decent equity fund. However the early load means the first three-year performance will be very unimpressive.
One can make a case for ULIPs as investment vehicles but most holders are unaware of structure and break-up. If they do need the insurance, they will be disappointed to realise that it is far lower than they expect for what they think of as their "premium".
It's impossible to make a case for money-back policies. People above a certain age can be forgiven because these were the only instruments available until recently. Indeed, even in the 1990s, LIC offered generous returns. But that is no longer true. The real interest rate on a money-back policy is negative.
A term policy offers far more efficient cover. If the differential between the term premium and the money-back premium for the same cover is invested in any respectable financial instrument for any reasonable period of say, five years or more, the combined returns are always in favour of the term-plus investment versus the money-back.
People who go in for ULIP think of these plans as "insurance" whereas they are really investment instruments with add-on insurance cover. People take money-back policies to get a return on their "investment" from a pure insurance instrument. And, they ignore term plans, which actually offer the best insurance cover!