Last week, I wrote about the annual Buffett and Munger show from Omaha, Nebraska.
However, as one would expect in a six-hour QA from the two, that was hardly enough to cover the stream of wisdom and fascinating observations found at the event.
One part I found relevant to the state of financial products in India was Buffett talking about the power of bad incentives.
Thats a topic Munger also railed against in an interview given at the same time as the shareholders meet.Theres probably nothing that damages the personal finances of savers than encounters with salespeople who have been incentivised in a certain way.
Munger says in the interview: Im afraid that salesmen do have a wonderful incentive.
what a salesman will do is just awful, if you give a man a family to support, in the commission system.
Its disgusting.
My dead wife had a relative, her mothers cousin, who was a blind doctor.
And he had two adopted children.
And after he was blind, and he was living on the savings that hed made from working very hard and this goddamn broker who was married to the adopted daughter, he just churned the old guy until he was broke.
He was blind! He was his own father-inlaw! They just think if you need it enough, its OK to do.Thats quite a comment on the culture of commissions: They just think if you need it enough, its OK to do.
From our own experience in India, we know that almost all the problem in personal finance arises from malpractices driven by the system of selling on commission.
Whatever be the kind of product being sold, if the seller gets a percentage of the amount invested every time theres a transaction, then you can be sure there are going to be a lot of transactions.
Theres no real way of stopping it, except by changing the model of payments.At its heart, this incentive problem is one of severe misalignment of the interests of the customer and the salespeople.
People will follow their own economic interest.
In almost every financial product, the customer (or saver or investors) benefits when the product delivers over a long period while the salesperson benefits from the act of selling itself.
Even if the salesperson gets paid something over a long period, a big chunk of it is up front, and thats the real problem.
Indian mutual funds are now an exception to this.Map this on to any personal finance service of the kind that Munger talks about.
Its in the sellers interest that you keep buying and selling.
Every time you buy a new investment, a commission is generated.
In services like stock broking, the same is true of selling.
The best scenario for the saver is to find a good long-term investment and stay invested.
This leads to the highest returns and lowest taxation.
However, this is also the worst scenario for the intermediary because there are minimal transactions.
This is a stunning mismatch of economic incentives.
In fact, saying mismatch is a huge understatement this is an adversarial model, where the intermediary is necessarily an enemy of his client.Well, not necessarily, because the seller can be good enough to worry about the long-term well-being and loyalty of the customer.
He may say to himself, Ill put my own immediate interests on the backburner so that the client has a good experience and becomes a customer for life.
Does anyone do that In my experience, a certain number of individual advisors do so but institutional ones never do.
Thats because institutional sellers are bound by the incentives of the organisations themselves, which are transaction oriented.After about a decade of tinkering, Sebi has evolved an incentives structure for Indian mutual funds which is immune to these problems.
There are no upfront commissions possible and there is no incentives for churning the investors money.
Many sellers will divert to other products--like insurance--that havent been cleaned up by the regulators.
Still, investors who understand the power of incentives can do enough to save themselves.