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Managing the Financial Relationship with your Bank


“FIDELITY Fiduciary Bank”. Anyone who has seen the musical classic Mary Poppins will know this song too well. A century has passed since the timeline of the show but the two words, “fidelity” (loyalty) and “fiduciary” (trust) remain hallmarks of the banking system.

After all, you would not want to put your hard earned money with an institution which you do not trust nor feel is loyal to your interests.

Banks today are not what they used to be. From run-of-the-mill savings and current accounts and standard credit facilities during our grandparents’ time, commercial banks are now a one-stop centre for all your financial needs. You can get special accounts for every member of the family, credit cards to suit all lifestyles and requirements, loans for innumerable purposes and financial products such as insurance and investments.

Although most of us have dealings with more than one bank for reasons of location, competitive rates or selection of products and services, it is quite likely that for the majority, there is one bank favoured over the others where we have invested the bulk of our financial transactions, along with the financial relationship which has been built over the years. Naturally, as the customer, you feel a high level of trust and sense of security with your banker who looks after your banking portfolio, from your current accounts to your personal and business loans.

Picture this scenario: A customer walks into his regular branch to perform some banking transactions. While waiting, the banker pleasantly introduces “an interesting new investment product” that has “very good prospects for returns”. Fifteen minutes later the customer is still listening to the product sales pitch.

Because of the good rapport established, he ends up signing a form to buy the investment product without further queries, believing it to be the right move. It is only when he reaches home that it hits him – how much did he bother to find out about the product before taking the plunge? Was the investment product right for him or was he swayed because of the long standing relationship with his banker whom he even regards as a friend.

The fact is, commercial banks exist for the sole purpose of making money. They are, after all, business entities and businesses need to look after their bottom line. Besides taking in deposits and giving out loans, banks will look to increase its non-interest income through insurance distribution and sales of investment products, among other things.

Banks have also ventured into the realm of offering wealth management products. As the bank manages its customers’ accounts, it is assumed they are in a position to assess the suitability of certain financial products for them as well. However, this isn’t always true. Contrary to what is believed, the information available to the bank is limited, as the bank does not have complete knowledge or understanding of the customer’s overall financial position especially in areas outside of the bank’s purview.

Although the bank’s representatives may try to make recommendations to the best of their ability using what little knowledge they have of the customer, history has taught us that the risk of selling the wrong products to customers is very real and could happen to anyone. The case in point being the Lehman Brothers minibonds saga that dashed the hopes of investors in numerous countries including neighbouring Singapore where the bonds were sold through local financial institutions.

While the Money Authority of Singapore took an active role in helping those affected, it also reminded investors that they were ultimately responsible for their own financial choices and should make the effort to understand what they were investing in. If the caveat emptor (let the buyer beware) rule applies to generic consumer products and services, it should rightly be observed when dealing with financial products and services as well.

Let’s take a look at an example of a popular investment product distributed via banks – structured products. “Capital protected” and “unlimited upside” are often touted as the benefits offered by these investments.

How are these products designed to achieve what they claim to offer? In a nutshell, structured products are designed by taking a traditional security, such as a conventional bonds and combining it with the prospect of performance returns derived from one or more underlying assets. Only a fraction of the total investment is placed in the investment underlying usually via a call option on an equity instrument, such as common stocks, or an index like the MSCI Asia ex Japan.

Whatever returns gained by the call option is then shared by the total investment. What differentiates one structured product from another just boils down to the underlying call option. In the best case scenario, your call option delivers a meaningful return for the total investment value. In the worst case scenario, your call option will expire without any returns and you get your principal value back. However, any early redemption will result in you getting the market value of the investment at that point in time, less redemption penalties if any. This may be less than your original principal amount.

How structured products work

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So, are structured products suitable for everyone?

Unlimited upside potential with no downside risk sure sounds attractive, but most people I speak to tell me their investment returns have been modest at best. Many have actually received only their principal investment value back after 3, 5 or 7 years when the call option on the underlying investment failed to yield any returns.

Given the limited upside potential and capital preservation focus when viewed in its entirety, structured products may be more suitable for very conservative investors who want to diversify some of their cash reserves away from plain vanilla bank deposits. In comparison, if you are aiming for higher returns, required to meet your various long-term financial goals, this product is not for you. The truth is that there is no one-size-fits-all investment product which can meet everyone’s needs.

While it is desirable to maintain a good rapport with your bank, it is important to be aware of the consequences of any investment and not rush headlong into any decisions out of a sense of reciprocity or obligation due to a long standing relationship.

So how can you as a customer, effectively manage the financial relationship with your bank while at the same time, ensure that you are making the right financial decisions?

First and foremost, take a look at your goals and investment objectives; what investments you already have, what you can afford, your risk profile and asset allocation. Next, you should buy only what you fully understand. This means being familiar with the product’s benefits, risks, limitations and costs. Ask yourself, will this product complement, supplement or replace what you already have? Or will you end up being over-exposed to a particular risk? To circumvent any shortcomings, one should ideally have a tailor-made holistic financial plan that will act as a guide to select the right investment offerings based on the individual’s unique financial and investment circumstances.

Equally important, know how much you can lose in the worst case scenario and how this may happen. Many investors are so preoccupied with the potential return on investment that they overlook getting a clear picture of a return of their investment, should an early exit strategy become necessary.

Lastly, make it a point to find out and know the upfront charges or costs attached to a particular investment product before agreeing to sign on the dotted line.

A solid financial relationship with a bank is a privilege and advantage.

That said, investment decisions are not to be taken lightly, nor regarded as a regular banking transaction. By being duly diligent and by recognising the bank’s strengths and limitations, you are in a better position to work the relationship to your advantange.

 

 

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