Monday, April 27, 2009

Creating or destroying value?

Business should create products that give value to customers. If the cost is $X and the value to the customer is $Y, then the business is entitled to keep the difference to cover its marketing cost, expenses and profit.

For tangible products, the customer can assess the value of $Y by looking at the price of similar products. 

For financial products where the future value is uncertain, such as shares, structured products, life insurance and land banking products, it is difficult for the customer to know the real value. This allows the experts (i.e. financial advisers or businesses) to exploit the ignorance of the consumer by giving misleading advice.

The technique is to give the promise of a future value that is not likely to arise. For example, that the asset will appreciate in value. Usually, this is based on looking at the price movement in the past and selecting a period that shows the most favourable results. This is misleading.

All businesses, if it is runned well, will give a modest rate of return. If inflation is 2% per year, a return of 5% is reasonable. If the business projects a return of 15%, it is not reasonable. The business is taking excessive risk, e.g. through leveraging, or playing a speculative bubble, such as the US housing market (funded by subprime mortgages).

The promoters of these financial products take in a lot of money from investors by making unachieveable promises. They take away a large portion of their money in marketing expenses and profit. The leave the investors with assets that have depleted in value. Eventually, the investors have to realise their investments at a big loss.

Look at the history of many time share, land banking, structured products and life insurance products. While some of these products, give good value, the majority of these products destroy value for the investors.

Be careful about these types of financial products. Do not believe that the assets will appreciate in value. Often, there is someone behind that will cream off your gains and leave you with a poor yield.

Tan Kin Lian



David said...

The problem is, those products that are of good value, no agents will want to sell due to the low commission. Even the insurance company may not even want to sell directly, telling you instead to use their agents.

So customers face obstacles to get good products but are swarmed by bad products, everywhere and in everyway. Of course some or even many will succumb, especially given the tentalizing baits that these agents used.

Mr Tan, I remember that you mentioned wanting to start a channel(or something like that) to overcome above, eg low cost, good products and easily accessible, like online and ready in 2009? Any updates on the status?

Parka said...

Withholding of information isn't new. Even the HDB is doing that. Ever wonder how much it takes to build a flat? It's a national secret that can never be revealed. It's really a case of if-you-know-you-have-to-die.

Information is money.

Withholding information is easy. Harder is explaining the cost involved and persuading customers the value is there on top of the cost. This is where the marketing department comes in.

For businesses to have only a return of 5% is ridiculous. Businesses that earn less than that will be wiped out instantly in a financial crisis because they have no retained earnings.

No one in the right mind will start a business for a return for 5% considering the amount of risk put in. Might as well take a salaried job instead. Less risk upfront.

I get that this article is going for financial entities again.

I believe the real question in the article is "How much should the financial institutions earn?". My answer is as much as they can provided they earn for their customers first. Principle of equivalent trade — in order to get something of value, something of equal value has to be sacrificed.

It is also very important to declare to customers how much commission the promoters are getting. Every customer should ask this question. The customer should never buy if there's not a clear number.

If there should be any amendment to the financial regulations, I will say that declaring commission amount is a must.

It's very simple, show me how (not how much) they are paid and I will show you how they behave.

Unknown said...

Good News to consumers!!!!

commission will come to pass soon.
MAS will remove commission as way of remunerating the insurance agents.
Reward will commensurate with scope of advice and works in the form fee/commission(low) or fee .Product pushing or form filling insurance agents will be paid a low commission, eg 5%.
AXA will lower the product commission in anticipation of these changes to help their advisers get used to it.
Consumers can expect to pay less or get money worth service and advice.Consumers will know upfront how much they pay in fee/cost before work begins.
This is to eliminate the product pushers and form filling or execute only salesmen.

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