Caveat Emptor!

by George Hatjoullis

In a free society a degree of personal responsibility is healthy. The corollary is that a society in which personal responsibility is regulated away may be less free and no so healthy. So when beverage sellers feel the need to print ‘This coffee is hot’ on the receptacle in which the hot coffee that I ordered is served to me, I start to be concerned. Nowhere is this demise of personal responsibility more disconcerting than in the financial services area. The net result may be counterproductive in that good advice may become prohibitively expensive to cover liability insurance and liquidity in financial products will continue to diminish because capital will find it unrewarding to commit to providing liquidity. I suggest this is already happening.

The retail investor (you) can do a good job of protecting yourself by observing a few common sense rules.

Rule 1: If you do not understand it do not do it. Seek advice but do not expect someone to tell you what to do. Ask them to explain what are your options and what are the risks (especially worse case). Advisors can only help you understand. If they are making decisions for you then I would be worried. In order to make good decisions on your behalf an advisor needs far  more information than it is possible to collect (or that many will divulge). Make your own decisions and only do what you feel comfortable doing. If you understand what you have done and why you have done it you are more likely to recognise if you were wrong or circumstances have changed.

Rule 2: If it looks too good to be true then it almost certainly is not true. Why do you imagine someone has a great opportunity that they want to hand over to you? People in financial services are in it to make money for themselves. You might imagine that it is good business to look after clients. At best they will act within the regulations. Some institutions work on a client turnover approach. They expect to lose 10% of clients each year but expect an equivalent number of new clients to join. Customer service is not necessarily high on the agenda only staying within the law. You need to ask yourself, ‘what is in it for them’ and factor in your conclusion. See also rule 5.

Rule 3: Beware guarantees. A guarantee is only as good as the guarantor. It may seem that the guarantor is an institution that is unlikely to fail but read the small print. Big institutions are not averse to packaging products into separate entities that have no recourse to the originating institution. This was a major feature of the 2008 financial crisis. It is also quite common in structured products today. The product may be protected by the FSCS but this protection is specific and limited. Check what is actually protected. The product may be regulated by the FCA but this may mean very little. If you cannot be bothered to follow up then get someone you trust to explain or walk away. Missing a good opportunity is better than investing in a scam.

Rule 4: γνῶθι σεαυτόν or know thyself. This is not for philosophical or spiritual enlightenment but so you can get your finances on track. Be clear on what you are trying to achieve and why the strategy you have chosen should achieve it. Recognise up front how the value of your portfolio might normally vary (and don’t panic if the worse limits are approached or get excited if the best limits are approached). To change strategy you need either to have changed objective or have new information. If neither apply why are you acting?

Rule 5: Be realistic. If NS&I is offering 1% on an income bond (a totally risk free investment) but someone offers to sell you a bond paying 7% think risk! There is a reason the bond offers 7% and it is not charity. The bond may not repay in full. Your capital is at risk. Can you afford not to be repaid in full? If not then take the income bond or a low-yielding risk free gilt.

I could go on but I think my point is made. Financial acumen may help you get ahead but if you do not have it and are not inclined to acquire it then at least try not to be daft. If you apply the above 5 rules it will help you avoid the main pitfalls. Caveat emptor!