Addition to The Income Pyramid
The conventional income pyramid includes low income, middle income and high income and that’s about it. I guess we need to add a couple more groups classifying one’s wealth. Addition of high net worth and ultra-high net worth might just be the key in today’s world since the income disparity gap had widen significantly.
Let’s take the article’s example to explain the illustration above. If you are at the high income range of the group, most probably all your wealth came from high paying salaries which allows you to save more compared to people earning lower salaries. These group consist mainly on professionals or mid-high level managers. Chances are you have $100k – $300k worth of savings in your bank account and bankers might want to recommend some product deemed ‘alternative investment plans’ that puts your money into work outperforming normal rates.
The Bond
In the article, the bank recommends a SGD 150,000 bond to its client stating that it pays out around 7% of dividend every year which meant that the bond would pay out SGD 10,500 annually guaranteed until maturity. That sounds great and a very suitable product for a passive investor to earn something above term deposit rates with the cash placed aside for her children’s education.
In fact, bond could be priced at differently throughout its life. The pricing could be below its actual price of 100.00% depending on the market conditions or the state of the company. One could be buying a bond at only 96.78%.
Priced at the 96.78% level actually meant that for a SGD 100,000 outlay one could get 103,327 arbitrary units in total. At the end of maturity, the company would pay back the original 100.00% meaning the SGD 100,000 invested would turn into SGD 103,327 excluding coupon payments. That’s an immediate gain of 3.22% just on bond pricing alone.
Looking at the chart above, Swiber bonds might have been offered to clients when oil prices started to rebound in April/May 2016. It definitely seems attractive since the maturity is less than a year away and the bond value is priced below 100.00%. (referring to SWIBSP 7.125% 18 Apr 2017 in the table below)
Too Good To Be True?
It sounds too good to be true isn’t it? Well it probably is… To be exact, the conditions are true but only within ‘normal’ parameters. During the extremes, factors such as a huge drop in oil price can cause the decline in one’s income and immediately affect the ability of the company to pay its debtors.
This happened to Swiber Holdings and bondholders are stuck since they can’t actually sell with bond value dropping 25% with maturity closing and holding on would equal driving into a smokescreen not knowing what would happen. Investors would settle with the hold and pray approach waiting for a bail out in the end getting their full sum back.
Conflict of Interest
This is where moral hazard steps in. Bankers are there to make you buy products from them but is the 7% bond suitable for the investor in the article? Riskier products should be offered to high net worth individuals since a loss of SGD150,000 isn’t going to bite them much as at any given day their bank accounts have 7 digit numbers just sitting there doing nothing. The mis-match of profile comes into question when products are offered and that is a serious issue.
At times, both parties are responsible when issues like these arises. The banker could be offering very good stable bonds which are just +2% above benchmark rates but that might not seem appealing to an investor. One might have thought that benchmark +2% isn’t worth the risk with hidden fees along the way attached to the product.
This is where an investor’s interest collides with the banker’s interest. In return bankers would try to seal the deal balancing yield of products and pricing so both parties could come into an agreement where the investor would find the risk to reward ratio favorable. Indeed, favorable but not suitable…
Financial Literacy Importance
Financial literacy becomes a necessity no matter who you are. Many do not earn their money from the financial markets and some work hard in highly specific technical industry like engineering, healthcare or science related research which have little to no contact on what’s going around the world on their day to day jobs. Their contribution to society is huge and in return bandits at the gates try to rip them off? This isn’t right at all. These people tend to land on high income group and earn a huge salary for their jobs and willing to invest as a form of diversification and seek the industry know how of bankers.
But little do they know that without minimum financial knowledge about the products so called ‘wealth protection’ that they are offered, one might be burning their hard earned cash away just because they put their trust in a banker that is just present to make sales target.
Just Hate Being Treated Like a Fool
We originate from the investment buy-side of things and deal with tonnes of bankers. We had been offered products that a fool might point it flaws with resemblance to what Jared Vennett (played by Ryan Gosling) in the movie The Big Short calls ‘dogshit’ offered by those bankers.
People in the industry like us knows what’s happening and bankers still dare to recommend questionable products. To a person which have no idea about the markets, I really can’t imagine what ‘magical’ products are being offered.
Be sure to be alert on your next investment and don’t trust a hundred percent of words by the people who offered you the product.
Like our page to get more these https://www.facebook.com/omightycap/
Make the next post easily visible from your Facebook!
You can visit us at http://omightycap.wordpress.com
