Once in a while, a book comes along that articulates exactly what you have been thinking for years. Why Personal Finance is Broken and How to Fix It by John Campbell and Tarun Ramadorai, two distinguished academics with deep knowledge of both Western and Indian financial systems, is precisely such a book.
Reading it felt like encountering a rigorous academic validation of the principles on which I founded Value Research three decades ago and have been advocating ever since. The authors have done the hard work of compiling evidence from many countries, including India, to demonstrate what observant investors already suspect: The personal finance system is not an accident; it is designed that way.
The book’s title contains a clever double meaning. Personal finance is “fixed” in the sense of being broken, but also “fixed” in the sense of being rigged. The authors argue, with substantial evidence, that the financial services industry does not profit despite your mistakes—it profits because of them. This is not a conspiracy theory but simply the logical outcome of how markets respond to demand.
Phishing for phools
Here is the sad truth: Capitalism, the best engine of prosperity in human history, responds to what people want, not to what they need. When customers accurately understand quality and price, competition delivers excellent products at reasonable costs. But when customers are confused about benefits and blind to costs, the same competitive forces deliver exactly what confused customers think they want—products with exaggerated benefits and hidden fees.
The authors call this “phishing for phools”, borrowing a phrase from Nobel laureates George Akerlof and Robert Shiller. Financial firms are not being evil (well, most of the time); they are simply doing what profit-seeking businesses do.
Consider how this plays out in practice. Nothing impresses us more than features, jargon, and complexity. Our technological world has trained us to believe that if something is complex, it must be sophisticated and therefore good. The financial industry has learned this lesson well.
A simple term insurance policy that does exactly what insurance should do, protect your family if you die, earns the seller a modest commission. A complicated unit-linked plan, bundled with investment features that most buyers barely understand, earns the seller far more. Which product do you think the industry is more enthusiastic about selling?
The authors draw a parallel with medicine. A century ago, the marketplace for medicines was competitive and unregulated. Advertisements celebrated the health benefits of tobacco, and snake oil salesmen competed alongside genuine doctors. Society eventually recognized that free markets, left to themselves, would cater to demand for quackery just as readily as demand for cures. The result was modern medical regulation, in which complex treatments require prescriptions from trained professionals, while only basic remedies remain freely available over the counter.
Of course, I don’t personally agree with this example—modern medicine has its own huge set of ethical problems, many of which are worse than financial ones—but that’s not our topic today.
Radical simplicity is your defence
Personal finance, the authors write, remains stuck in that pre-regulatory era. Complex products that can damage household finances are sold freely to anyone who can be persuaded to buy them, while simple products that would serve most people well struggle to gain market share because they generate insufficient profits.
What can individual investors do while waiting for systemic reform that may never come? The answer, as I have always argued, lies in understanding that complexity is not your friend. Every additional feature, every bundled benefit, every impressive-sounding strategy is an opportunity for costs to hide and for your interests to diverge from the seller’s.
The financial industry has spent decades perfecting the art of making the unsuitable seem attractive. Your defence is radical simplicity: A term insurance policy for protection, a few well-chosen mutual funds for investment, and the discipline to ignore everything else. Long-time readers of this column will recognize this as precisely what I have been saying for decades. It is gratifying to see two distinguished academics arrive at the same conclusions through rigorous research.
The book confirms what three decades of watching this industry have taught me. The system is indeed fixed—in both senses of the word. But knowing this is the first step towards not being its victim.
Dhirendra Kumar is the founder and chief executive of Value Research, an independent investment advisory firm.