The alchemy fallacy – Guest blog from Ralph Frank


The 2014 Edelman Trust Barometer found that financial services is the least trusted major industry, with a score of 48% globally (technology is the highest at 79%). Trust in UK financial services is even lower than the global average, coming in at 37%. A reason often cited for the lack of trust in financial services is that results delivered frequently fall short of the expectation created pre-purchase. Three of the main drivers behind this over-promise/under-deliver cycle are: incomplete disclosure of costs, ineffective risk management and creation of unrealistic expectations.

The issue of disclosure of costs is one that is gaining increasing attention – and not before time, as discussed in previous blogs. Full disclosure of costs allows consumers to make better informed purchase decisions. Incomplete disclosure distorts the value assessment process, increasing the likelihood of inappropriate decisions being taken. If savers are aware of a high level of fees being embedded in a particular product, they will be able to better consider whether the gross of fees return required to achieve the advertised net of fees outcome is realistic or not. Addressing the issue of full and consistent disclosure of costs across different markets is a key part of building trust in financial services.

A robust risk management process, built on top of a clear understanding of what the underlying risks are, will increase the likelihood of financial products delivering the outcome anticipated. History is littered with examples of products based on financial assets with characteristics quite different from the objectives the products were meant to deliver on – equities and guaranteed annuity rates as well as equities and mortgages are two that spring to mind. Attempts at return maximisation, even over the long-term (whatever that might be), have often resulted in trust minimisation.

Many financial products are sold by creating an expectation in the purchaser’s mind of the return that might be earned. However, these return expectations frequently require modern-day alchemy in order to be realised. It would be quite easy to avoid the subsequent disappointment by not indulging in some of the fallacious explanations of how such returns might be achieved in ideal situations – particularly when the fine-print in the accompanying documentation sets out a mind-numbing range of caveats as to why the ideal situation might not come to pass.

Many estimates that savers receive from their providers as to the likely growth of their savings currently assume a central case rate of return of 5% per annum. Is 5% per annum realistic in a world where short-term interest rates are effectively zero, ten year UK Government bond yields are less than 2% per annum and thirty year UK Government bond yields are less than 3% per annum? These Government bond yields represent, in my opinion, the risk-free rate for a UK saver. ‘Risk-free’ means that there is certainty, as far as possible, that the provider of capital will receive a full return of their capital and interest. If you seek to earn a higher rate than the risk-free rate, you have to take investment risk and likely incur a management charge too. A central case that assumes a return of over 2% per annum, net of fees, above the risk-free rate feels like a recipe for under-delivery in many cases to me.

What do the financial services industry and its clients stand to lose in the long-term by seeking to break the cycle of over-promising and under-delivering? The initial messages given to savers might cause them to be unpleasantly surprised by the quantum of saving, both timeframe and contributions, they need to undertake in order to achieve their goals. Those dissuaded from investing, by the low return projections based on the risk-free asset, will likely have been better served by not setting themselves up for the near-certain disappointment that unrealistically high return expectations might create. Others might benefit from paring back their goals to more realistic levels.

The sooner a problem is identified, the more likely it is to be successfully dealt with. If the resulting savings programmes and related products deliver more than was initially anticipated, contributions and/or timelines can be cut back as a reward for the early discipline. These outcomes are likely to build confidence in the financial services industry, attracting more support in the long-term. The likelihood of persistent alchemic success in financial services is of a similar order to that in chemistry – why pretend otherwise?

About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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