Of Suckers, Mutual Funds and the Old Rs 10 Per Unit Trick

There is a sucker born every minute. I was reminded of this earlier in the day today, when late in the afternoon, that time of the day when I snooze after having had my lunch, I got a random call. For some reason, truecaller didn’t pick up the name of the incoming caller, and I took the call.

The call was from a financial planner’s office and a female was talking at the other end. She said a new fund offer (the technical term for a new mutual fund scheme) from a mutual fund was being currently sold, and that I should invest in it. (Why in the world would I invest in a new scheme and not in something tried and tested, is a question that I didn’t bother to ask).

She started with the usual bull about the long-term returns on the mutual fund expected to be very good (Again, I didn’t bother to ask, if she knew the future, why is she making a living making calls. That would have been very mean).

I replied like I usually do when I am not interested, with a polite hmmm, which doesn’t mean anything.

And then she let it slip, very casually: “Sir, units are available for just Rs 10 per unit.” That caught my attention. It had been years since I had heard that.

The oldest mutual fund misseling trick, something I had made my career writing on during the days I used to write on personal finance, ten to fifteen years back.

It took me back to 2004 to 2007, when stocks were rallying big time and new equity mutual fund schemes were launched dime a dozen. I was reminded of one scheme which had a theme of investing in stocks depending on where the head office or the registered office of the company was (some such thing). Those were the days my friend. Anything sold.

Hoardings on bus stands across Mumbai were plastered with the advertisements of new mutual fund schemes, with the Rs 10 price at which you could buy a single unit of the scheme, being prominently displayed. Even the mutual fund was trying to anchor the prospective investors to the price of Rs 10 per unit.  

As Jason Zweig writes in Your Money and Your Brain in the context of anchoring:

“That’s why real estate agents will usually show you the most expensive house on the market first, so the others will seem cheap by comparison and why mutual fund companies nearly always launch new funds at $10.00 per share, enticing new investors with a “cheap” price at the beginning. In the financial world, anchoring is everywhere, and you can’t be fully on guard against it.”

The stupid me had assumed that all these misseling tricks would have been replaced by newer ones by now. But I guess with every bull run a new set of suckers are produced and India is a big country.

Anyway, I told the caller, madam no money. She then made some polite noises about this being a good opportunity and I should invest in it, and that was that.

For people who don’t know about this misselling trick this is how it works.  When a new mutual fund scheme is launched, the price is set at Rs 10 per unit. Investors buy these units. If the mandate of the scheme is to invest in stocks, the mutual fund collects the money and invests it in stocks.

The price of a unit at the launch is set at Rs 10 per unit. This creates a perception of a cheap price in the mind of the investor. The older schemes, given that they have been around for a while, have higher prices.

Let’s say an older scheme which has been around for a while has a price of Rs 100. This higher value is because the scheme was launched many years back and the stocks that the scheme invested in over the years have gone up in value. In the process, the price of the scheme has also gone up.

Now let’s say you invest Rs 1 lakh in the scheme with a price of Rs 100. Assuming no expenses for the sake of simplicity, you will get 1,000 units (Rs 1 lakh divided by Rs 100) of the scheme. Now let’s say instead of investing in the old scheme, you end up investing in the new scheme at Rs 10 per unit.

You end up with 10,000 units (Rs 1 lakh divided by Rs 10) in the new scheme. 10,000 units is ten times 1,000 units. This creates the perception of a cheap price in the mind of the investor, thus misleading the investor into buying the new scheme and not the old scheme.

But does it really matter? Let’s say the new scheme invests in exactly the same set of stocks as the old one. The price of these stocks goes up 10%. Thus, the price of a single unit of the old scheme goes up to Rs 110 and that of a single unit of a new scheme to Rs 11. But the value of the overall investment in both the cases is Rs 1.1 lakh (Rs 1 lakh plus 10% return on Rs 1 lakh).

Let me explain this in even simpler way. Let’s say you have Rs 10,000 cash lying with you. You can have it in five notes of Rs 2,000, 20 notes of Rs 500, 50 notes of Rs 200, 100 notes of Rs 100, 200 notes of Rs 50, 500 notes and/or coins of Rs 20, 1,000 notes and/or coins of Rs 10, 2,000 coins of Rs 5, 5,000 coins of Rs 2, 10,000 coins of Re 1 or in different combinations of these notes and/or coins. 

But at the end of the day, the total amount of money would still be Rs 10,000. It wouldn’t matter what denominations of notes and coins you have that money in. In the same way, the number of units you own in a mutual fund doesn’t really matter. What matters is how well the money you have invested in the mutual fund scheme, is invested further, and at what rate it grows (or falls for that matter).

Which is why, it makes little sense in investing in new schemes. But it makes absolute sense in sticking to old schemes which have had a good track record. Of course, for the mutual funds it makes sense to rely on these subtle misseling tricks because more the money invested with them, more the money they make. 

Anyway, I didn’t think I would need to write this in 2021. But as the old French saying goes (and I don’t know how many times I have ended a piece with this), “plus ça change, plus c’est la même chose.” The more things change, the more they remain the same.

Of course, whether you want to be a sucker  or an informed investor, the choice is clearly yours. As the old Delhi Police ad went, marzi hai aapki aakhir sir hai aapka.

PS: An added bonus the legendary Baba Sehgal’s all time classic, mere paas hai mutual fund

Delhi’s real estate obsession defies logic

I was recently in Delhi to attend a few family functions. And as often happens in Delhi, when you want to make a conversation with someone you don’t know that well or you meet only once in a few years, you end up talking about real estate.

During the course of these discussions over plates of oily Kashmiri food, which I have stopped liking many years back, or cups of tea and coffee, I came to realise that the Delhi middle class is still obsessed with the idea of owning real estate. Of course, I am drawing this conclusion from a small sample, but that is the drift I get every time I go to Delhi.

This love for owning real estate continues, despite the fact that the real estate sector in Delhi and the National Capital Region (NCR) surrounding it, continues to be in a mess. Lakhs of people are still stuck with homes which are under-construction and have been under-construction for a while now. Despite this, still others are ready to buy under-construction homes so that when the price goes up, they can cash-in.

The arguments offered in favour of owning real estate all centre around a very basic point that the American writer Mark Twain made: “Buy landtheyre not making it anymore.” The thing is that everything that sounds sensible isn’t necessarily sensible.

The real estate scene in Delhi and NCR has been rather dull over the last few years. Prices in many areas have fallen by close to 20%. In areas where prices have not fallen they have been stagnant. In fact, investors in real estate would have made more money with a greater peace of mind, by investing their money in bank fixed deposits. In fact, even if they had let their money sit idle in savings bank accounts paying 4-6% per year, they would have made more money.

Nevertheless, those who own more than one home, continue owning their second or third home, in the hope that the trend will reverse and they will make money someday. This during an era when the rental yields in Delhi are around 1.5-2%. Rental yield is essentially the annual rent that can be earned from a home divided by its market price.

Owners of real estate miss out on this return as well primarily because there is a great fear that once a home is let out, the kirayedar for the lack of a better word (tenant just doesn’t sound the same) will not vacate when the contract runs out.

In fact, I know of people who have bought a second home on a home loan, as an investment. In some cases, the home is still under-construction. This means that the interest on the home loan needs to be paid, without the possession in sight. In cases where fully-constructed homes have been delivered, they are paying an interest of 10-11% on their home loan, while getting a rental yield of 2%. Some tax benefits are also there.

But the basic question is why would you borrow at 10-11% and earn a return of 1.5-2% on it? Beats me. For those who have put in their savings, it still doesn’t make any sense to be earning 1.5-2% per year, when the rate of inflation is 5%.

This proposition only makes sense if the money being deployed is black money (i.e. no tax has been paid on the income earned) and cannot be invested through the conventional modes of investment. The irony is that it takes more paperwork in India to open a bank account than to invest in real estate. Also, real estate comes with own share of hassles. There are maintenance charges and property taxes to be paid every year and these eat into the savings of real estate owners.

Nevertheless, these people are still confident that real estate prices will rise someday. And they are not ready to sell in at the current market price. Why is that?

They are ‘anchored’ to a certain price. As John Allen Paulos writes in A Mathematician Plays the Stock Market: “Most of us suffer from a common psychological failing. We credit and become attached to any number we hear. This tendency is called the “anchoring effect” and it’s been demonstrated to hold in a wide variety of situations.”

How does this apply in case of the real estate scenario in Delhi and NCR? The current crop of investors in real estate has heard numerous success stories and the huge amount of money and returns made by the investors in the past. They are anchored to these returns and are waiting for higher prices. This means they won’t sell at current prices.

There hope of higher prices won’t materialise anytime soon given that a huge amount of homes are still under-construction. In many cases the construction has stopped. At the same time new home launches continue.

What people also don’t realise is that even in a situation when prices are not falling, they are losing money once they start taking inflation into account. This is referred to as a time correction. And that is clearly on in Delhi and other parts of the country.

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The column originally appeared on Huffington Post India on December 9, 2015