11 February 2015
Does it matter if I don’t understand what I’m buying?
Complexity is at the heart of just about every financial product you might care to mention these days. Even savings accounts - seemingly the most simple of concepts - come with pages of terms and conditions. Some investment products meanwhile, come with multiple booklets for the customer to digest - each of which is as long as a short novel.
The downside to a world where every bank account and insurance policy comes with 25,000 words of small print is that it's impossible for customers to fully engage and understand what they're buying. Furthermore, it gives companies the chance to take advantage of their customers' lack of knowledge - using complexity to their own financial benefit, and to the detriment of their customers.
In such a world, the role of the regulator becomes all the more important. With the consumer unable to make true comparisons, and unable to deliver any true competitive pressure on financial companies, it's up to the regulator to protect the customer from being mistreated.
But it's not too hard for companies to increase complexity to such a point that even the regulators struggle to keep up - at least in the short-run.
The simple utopia
Although I'd love to see a world where the features of every financial product could be contained within a side of A4, it's never going to happen given where we've got to in the evolution of our financial services industry. In a utopia, perhaps travel insurance would pay out for anything that went wrong on your holiday - no questions asked. Or investment funds would do no more than invest directly in a portfolio of equities or bonds - no derivatives or complex fee structures.
But in such a utopia, every financial product would be much more expensive. There could be no cut price insurance, which excluded some of the more expensive elements of coverage. There could be no exchange traded funds which allow you to track the stock market at a fraction of the price.
Just as forcing simplicity on customers is not desirable, complexity can't be outlawed either.
Nevertheless, the financial services industry should still be forced to continually challenge complexity in their products - and keep reminding themselves what fundamental needs their products are designed to serve.
I'm willing to accept some complexity in insurance, as it seems fair enough that insurers are allowed to draw boundaries around what they will and won't pay for. But in the world of investment, I find it much harder to be convinced that complexity is necessary. People invest to grow the value of their assets - and this can be achieved in very simple ways. Most of the complex solutions, such as with-profits and structured products - are designed to try and pander to customers who don't want to take too much risk with their money, but do want the upsides of the stock market when it's doing well. This is a reality that's not really achievable - and what companies should be admitting to these customers is that they could be sacrificing an awful lot of upside over the longer run by building in safety buffers in the short-term.
At worst, these products are simply taking advantage of customers' lack of understanding about risk and reward - and while I'm not necessarily questioning the intentions of every company who offers them - I think the investor universe would be better off without them.
Two weeks ago, after I wrote about with-profits bonds, some of the companies I name-checked came back to me to challenge my position, claiming that their take on with-profits was much more transparent than most of the products sold 10 or 20 years ago. While I don't necessarily doubt their intentions, there's no question that even after every attempt has been made to create a clear and transparent with-profits product, the result is still something that's incredibly complex.
There's just no way that the average customer in a with-profits bond - even the better ones - can understand all the complexity that sits behind the product. That means it becomes just another financial product that they don't engage in.
If we're to build a more financially literate and engaged consumer community, complexity for complexity's sake has to be eliminated. Sadly, it's not a simple job. It's complex.