Personal Finance: These companies want you to remain financially illiterate

We often hear that lack of financial literacy is hurting everyone. Most people find finance boring. Try this one: Open the bonnet of your car and try to explain how the machine works—its design and functionality. Or list the ingredients in your shampoo and face cream, so you can prove that you are an informed consumer.Feeling confident that most would fail both tests, let me plead for not imposing too many conditions for knowledge, literacy and information on investors. Everyone earns money and figures out how to use it. Not everyone is interested in the math, the power of compounding, the complexity of interest rates, or the legal jargon of offer documents.Finance is complex like any other technical subject, and it should not be mandatory for everyone to master the subject before taking simple decisions. To drive a car, I just need to know the basics. In finance too, investors need the basics and not the jargon-filled literature that throws numbers and tables at them, with alarming footnotes and fine print. Reaching useful financial products to investors is the business of banks, mutual funds, insurance companies and finance firms. These businesses have squarely failed to simplify what they have to offer to investors because they think complicated product proliferation is the nicest way to brow their trade. medium81634722The simple bank deposit continues to attract most investors despite the low interest rate and high tax incidence because everyone understands the product. What stops other products from being as simple? In a bank deposit, the accountability for the performance of the product is well defined. The borrower is the bank with an established business of making loans. Regulations tightly control how the bank would be capitalised, and how the loans have to be accounted for.The singular objective is to protect the depositor from possible defaults. To the depositor, feeling secure about the deposit, earning a defined interest income, and being able to access it anytime are all that matter. Investing in a bank deposit needs no special and advanced financial knowledge and is, therefore, a default choice for most. As finance developed, it got democratised beyond the deposit. An entrepreneur who needs money for expanding his business can come to the market with an offer of equity shares to members of the public. He can raise money from a large number of people, who are willing to bet on his business idea. Financial markets are made up of products issued by governments, institutions, companies and such entities that raise money from the public. medium81634728While this proposition enables yond the desk of the bank’s loan officer, it messes with accountability and responsibility in a manner that makes it complex for the common investor. The marketplace involves a large number of intermediaries who are “fee-based” and not “fund-based” like a bank.A bank deploys its own capital, manages its assets and liabilities for a profit, and is hit directly when a loan goes bad. A fee-earning institution like a brokerage, an insurance company, a mutual fund or a financial advisory is only offering professional services to reach various financial products to investors. The problem is that the accountability of these intermediaries is too weak and responsibility too low. Fee-based intermediaries thrive on volume and therefore, quickly turn into sellers and pushers of products. In the name of product innovation, they confuse the hell out of investors. medium81634737There are simply too many products and many of them needlessly complicate what they do. Financial literacy then focuses on products, features and performance, leaving investors clueless about how to choose. Investors can use choices, only as belong as they are able to figure what the basic performance parameters are. Despite the advanced technologies that enable cars to speed without the pedal, automobile manufacturers have kept the basic design unchanged, so that users are not confused. Financial products have sadly not been built on such basics that show empathy with the user.Investors do not know how markets have modified their choices and insist on the old equation of what I give and what I get, preferably pre-defined. When finance is democratised using markets, and when fee-based intermediaries move in, this equation cannot be defined in precise terms. Firms may succeed or fail; share prices move up and down; bonds may pay or fail; and performance of financial products is not guaranteed. Investors fail to grasp this complexity because they are unable to separate the basic fundamentals in finance from the complexities introduced by intermediaries. They do not know what to expect. Second, users learn from experience, not books.Investors’ experiences with financial products and intermediaries do not provide them with the confidence to trust and to use a financial product confidently. The challenge for financial literacy and regulation is to address these issues so that investors are able to participate in financial markets with the same ease with which they use bank deposits. Financial literacy’s focus should neither be patronising nor preachy, trying to get investors to learn technicalities that are of no interest to them. medium81634744Instead, investors should be helped in understanding how markets are different from banks, and how one should navigate this alternate system. For example, the core proposition of a mutual fund is diversification, and most investors do not yet know why it matters. We do not have a design for investor communication, which enables them to grasp financial markets, know what the risks are, and how the intermediary can help. Investors do not have the time or inclination to learn finance.They are looking for simple products and easy rules to decide. Financial literacy drives should begin with the basics and enable investors to transition from banks to markets. If they figure the steering wheel, gears, accelerator and brakes, they would not care about what lies beneath the bonnet. Even if it is the finest engineering marvel.The author is Chairperson, Centre for Investment Education and Learning.The story first appeared on ET Wealth