The 2 Most Dangerous and Costliest Words for Investors

Satish Joshi

Can you guess these 2 words?

I am sure you can but let me reveal it before I create more suspense.

The Awards go to “FREE and GUARANTEE” in no particular order. Yes, these 2 are the Rock Star words of most salespeople in this industry. If they have these 2 words (actually there are 2 more but these 2 do the job) in their arsenal they have the opportunity to become stars. Smart Salespeople know the power of these words and they use it to their advantage extremely well. I have seen the smartest of folks fall for these powerful words “FREE and GUARANTEE” like the Song of the Sirens.

What do many of the bank sales folks do? Tell you Fixed Deposit is Free and Guaranteed. Well, I will not debate on the Guarantee Part here but is it Free. Think about it. Free. Really?

I will be doing a separate post on this “The Real Cost of CASA and Fixed Deposits” shortly.

Likewise, this ploy of “Free and Guarantee” is used by many in the Life Insurance Industry. Though I had initially intended to write this post in a certain way, my colleague and our CTO Satish Joshi incidentally wrote a post along similar lines with an example I have always found fascinating. So over to Satish. I promise you will not miss a beat here as we have stitched it well 🙂

Today there was an advertisement promising a “Life-Long Guaranteed Income” after retirement so that you can enjoy your retirement worry free.

When I see anything that says “Guaranteed” my scepticism rears its head because I am a firm believer that there is no free lunch in this life (or even the next if you believe in it)! A “Guarantee” or a “Freebee of anything always has a catch.

The Pitch was simple:

Invest Rs.5.13 Lakh for 10 years. Get a Guaranteed Rs.4 Lakh per year for the next 40 years plus you will get your Rs.51.3 Lakh back when you reach 100.

Wow. What else is required you may think? Invest Rs.51.3 Lakh and over a period of time get Rs.2.11 Crore. And on top of that it is GUARANTEED. Gosh I must be so lucky that these divine fellows have decided to make this offer to me.

I therefore decided to analyse what was being offered –

In return for depositing Rs.5.13 Lakh per year for ten years, the offer guarantees that you will get Rs.4 Lakh per year for the next 40 years plus you will get 51.3 lakh back when you reach the age of hundred!

Attractive numbers, Large numbers, you get back almost 4 times what you invested, you not only get a guaranteed income for 40 years but at the end of it you will also get back the amount you put down in the first place – so a “free lunch” for 40 years!

Firstly, do you really think you will live to the age of 100 – of course you wish you would, and we wish you would. But look around you at people you know or used to know. How many have lived to reach 100 years? So, you are not realistically getting back 4 lakhs per year for 40 years, but I would venture to say for a considerably shorter period (20 to 25 years would be a good, REALISTIC guess). The Life Insurance industry works on probabilities and they know most people will not even though some will. There is an actuarial science behind these calculations and the numbers are run from a perspective to maximize the company’s bottom line.  However, that is not the real problem here. Let us assume for the moment that you do live for 100 years.

What are you really getting back?

Let us analyse this in two steps.

Step 1 – How much are you really investing?

The advertisement says 51.3 lakhs BUT what it does not say is over a 10-year period, the 5.13 lakh you pay every year actually earns a return. So, by the time you reach the age of 60 and complete 10 years of investments, how much would you actually have accumulated? At even a most conservative return of 5.7% (which is very close to what you will get for a bank fixed deposit) at the end of 10 years you would accumulate more than 70 Lakh. So, what you are investing is not 51.3 lakh but a good deal more. AND you are not being told that!

Step 2 – What are you NOT getting back by being paid Rs. 4 Lakh per year and ALL of your 51.3 lakh being returned to you at the age of 100?

Because of the money of about Rs.70 Lakh (to be exact Rs. 7047268) which you have accumulated, you can earn even at the same very conservative rate of 5.7% return, Rs. 401694 every ear AND at the end of 100 years you will get back more than Rs.70 Lakh (not 51.3 Lakh that is promised to you according to this deal). So, in this deal, you are not getting back about 20 Lakh of your money that you had saved!

By just putting your money yourself in standard “Safe” bank fixed deposits or similar conservative and safe products, you can actually get back more!

So, is this really a good deal for you? This advertisement plays on the GUARANTEE word and our psychology to look at absolute numbers very well.

What is more, this whole calculation assumes an abysmally conservative rate of return of 5.7%. With ANY reasonable thought and prudent investing, you should hope to earn at least a 50-60% higher rate of return than this.

Let us do this calculation with an 8% per year rate of return instead of 5.7%. Even 8% is a very conservative rate of return that you should be able to get without having to take any appreciable risk at all!

At that rate – if you save 5.13 lakh per year for 10 years, you can get back Rs 6.4 Lakh per year for forty years (50% more than what is promised to you in this advertisement) AND get back Rs. 80 Lakh when you reach the age of 100 – again more than 50% higher than what is promised to you in this advertisement.

While we are not emphasizing higher returns in this example, we are saying that the words FREE and GUARANTEE come at a very high cost. These are Real High Costs always hiding behind these 2 words and it is in your best interest to know about them and how to deal with these words. Do not let these words cloud your real thinking and judgement.

A wonderful quote by writer John Ruskin comes to my mind as I end this post. “There is hardly anything in the world that someone cannot make a little worse and sell a little cheaper, and the people who consider price only are this someone’s lawful prey”. Though this quote was written in the 19th century, it is still so relevant with the crafty use of the words FREE and GUARANTEE.


P.S. If an advertisement is too good to be true, it always is.