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Some countries offer employer-sponsored retirement plans for its employees. Typically, employees are required to make some choices as to the kind of investments they need to decide. However, such choices potentially can be too complicated. The decision not to decide often means that individuals look to their employers for guidance. Studies suggest that even when no explicit guidance is provided, employees infer that their employer’s default contribution rate or investment fund choices are “safe”. This is called the endorsement effect.
In Singapore’s context, most employers do not provide such retirement plans due to the compulsory national defined contribution pension scheme called the CPF. However, this does not mean the country’s residents do not suffer from the endorsement effect. There are 3 endorsement effects. These endorsement effects have been used by financial salespersons to sell their products.
The first endorsement effect is the perception that ‘famous’ brands are better. Many insurance companies have invested large amount of marketing in advertisements and branding. The perception is that all products recommended by them must be good. Unfortunately, no insurance companies can claim to have all the best products. In Singapore, there is only one insurance company that has never cut their bonuses for participating products and it is a relatively unknown company compared to the rest. Just because a company has a lower budget for advertisement does not automatically mean it is no good.
The second endorsement effect is this. I have heard of financial salespersons stroking the egos of their prospects by telling them that they have been offered to invest in funds which are normally only available to high networth individuals. These prospects may think that if the high networth investors invest in such funds, it must be good! The issue is that these funds are wrapped around an expensive structure which would erode the returns of these ‘high networth funds’. Moreover, many of these high networth funds are active managed funds. Studies have shown that active managed funds underperform the index.
The third endorsement effect is from friends. I always get queries from clients with regard to dubious investments. I will advise my clients to stay away from it. However, the trouble is that their friends invested and earn a huge returns. Since these returns are real, a number of my clients figured that through endorsements from friends, these investments must be genuine. Unfortunately, it was indeed a scam. This is how Ponzi works: the large return of the investments is funded by the investment of future investors recruited into the scheme. Once the amount of inflow is insufficient to meet the cash outflow, the entire Ponzi scheme collapses.
Many investors are prone to endorsement effect. My advice to investors is that if you are not sure, it is better to consult a professional investment adviser.
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