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Distrust can help in investor safety

The basic idea seems to be that somewhere, sometimes in this world, some people get rich miraculously fast and maybe it is my turn now. Maybe it is. But it would be foolish to bet on it. If something sounds to good to be true, then it IS too good to be true, writes Dhirendra Kumar.

india Updated: Jun 07, 2009 20:41 IST
Dhirendra Kumar

A few days back, police arrested a man called Ashok Jadeja. Jadeja was accused of posing as a holy figure and plying his trade across a wide swathe of the country from Gujarat to Punjab. Nothing remarkable about this --there are a lot people like this in India and despite everything, some of them do get arrested sometimes.

What caught my eye about this news was that this man's basic racket was financial. Shorn of its religious garb, he was essentially running a Ponzi scheme, rather like Bernie Madoff and countless others. It is the scale of the returns he offered that set him apart. His basic pitch was very simple—his investors gave him money and he returned three times the amount three days later. This is an unbelievably high rate of return.

Say, if you gave Jadeja one rupee on New Year's Day, he would return three rupees to you on January 4. If at that point you gave him back the three rupees he would return nine rupees to you on January 7, assuming he worked on weekends. If you kept doing this, your one rupee would have grown to more than the GDP of India by March!

Now, this is what I call the power of compound interest.

And there are people who believed this Jadeja. A large number of people, apparently. Some newspaper reports put the total size of the swindle at Rs 1,800 crore. I don't know whether this was the amount people had put in or whether this was what they were expecting to get, but there seem to have been at least a few thousand people who gave money to Jadeja in his short career of about five months.

One of the more amusing parts of this affair was that some newspaper and TV reports kept referring to his victims as ‘investors’. If this is what passes for investment in our country, heaven help us all. Jadeja’s ‘investors’ may be a special case, but financial credulity is something a very large number of people are guilty of, at some point or the other in their lives. We may not believe that a godman can triple your money in three days, but many of us keep all common sense aside when weighing expectations from mainstream investments like stocks or mutual funds.

The basic idea seems to be that somewhere, sometimes in this world, some people get rich miraculously fast and maybe it is my turn now. Maybe it is. But it would be foolish to bet on it. If something sounds to good to be true, then it IS too good to be true. At some level, this is a problem of one’s mental model of how investments work.

One of the basic qualities that you need to evaluate financial services is distrust. It sounds like a strangely negative attitude to recommend, but all purveyors of any financial service should be considered guilty unless proven otherwise.