Principles of time value of money can help us evaluate every financial decision
By Narayan Krishnamurthy | February 08, 2017

The first three months of the year are pretty traumatic for several people; especially those taxpayers who still have some room to save on taxes and are unsure of how to go about handling last minute tax savings. So, I had this friend’s nephew, a bright techie who wanted to know if it was a good idea to go in for an insurance policy in which he had to deploy Rs 12,000 a year for three years for him to collect Rs 10 lakh after 10 years. I asked him what made him believe that he would be able to collect Rs 10 lakh a decade from now by paying Rs 36,000 over the next three years.

His instant reply was that the illustration on the excel sheet demonstrated by the agent popped up the results. I find most insurance agents, like several other financial intermediaries, difficult to handle. All of them tend to come up with excel sheet printouts in shades of grey, with rows and columns of figures and assumptions that compute the desired outcome that will tempt the most rational of investors. Some smart intermediaries carry tablets to show their excel sheet prowess by changing the inputs and outputs as if it is a magic show that they are conducting. The exercise is mesmerising and the colours dazzling to make mundane math look so exciting and mouth watering.

Many a times, these people manage to get more than they ask for. For instance, Rs 12,000 a year is basically Rs 1,000 a month, which is simple to calculate for anyone. So, by showcasing a low hanging fruit of Rs 10 lakh in ten years by paying Rs 1,000 a month for three years; they would get the prospect to commit Rs 3,000 a month to receive Rs 30 lakh a decade later. At this juncture, the policy proposal document will come out, and so would a declaration form which would state that the working calculations are indicative and that the prospect has understood that it is not real returns.

Temptation takes over

The question that most buyer fail to ask, and something that they should do first is; if the workings are indicative why are they there in the first place, and what could they do if they did not understand them even for their indicative value? Try asking a financial product seller these question and chances are he would not reply to your calls. But, by showing a benefit, even if it is hypothetical and assumed, he managed to draw your interest in putting your money into such schemes.

I have encountered some very sane and senior bureaucrats who have in the past been lured into plantation schemes and even emu farming, without even questioning the viability. I don’t blame any of them, after all, for a smart salesman, all it takes is to come up with a neat set of colour printed brochure with charts and graphs showing how much their money would be worth in future to sell the idea. Why just insurance, even among borrowers, EMI charts make loans so easy to repay and convenient to fulfil their financial desires. Most do not understand the effective interest versus the quoted rate, or what the principal and interest repayment component mean.