- Not knowing what you do not know is most dangerous (Type I & Type II ignorance)

Not knowing what you do not know is most dangerous (Type I & Type II ignorance)

Written by Wilfred Ling

Monday, 07 June 2010

There are two types of ignorance. The first type of ignorance is: Knowing what you do not know. For example, I know I do not know anything about sailing. Don’t ask anything about sailing because I know I am completely ignorant about it. I label this as “Type I” ignorance. For Type I ignorance, if someone ask me about sailing, I’ll confess I am ignorant. The other party knows I am ignorant. If one day I need to do sailing, I’ll immediately seek help from someone who knows sailing. There is no pretence of knowing about the subject matter because of being self-aware of ignorance.

The second type of ignorance which I call the “Type II” ignorance is this: Not knowing what you do not know. This is the most dangerous type of ignorance. Why? For Type II, you’ve complete ignorance about the subject matter AND at the same time being unaware of your own ignorance about the subject matter. The danger is running the risk of “acting” smart when in reality is acting in mere stupidity. Take for instance, I know panodol reliefs the headache. If I am always having headache, I’ll take panodol. Let’s say it becomes a habit and instead of seeking medical advice, I assume that the headache comes from some stress and hence I keep on eating panodol. But there is a danger that the headache is due to a brain tumor rather than due to stress. If I do not seek medical attention, I do not what I do not know. If the status quo remains, I may just die of brain cancer due to my refusal to seek medical investigation. Such Type II ignorance is very dangerous but if professional help is sought, it can be change to Type I ignorance. For instance, I may decide to seek medical investigation and discovers is a brain tumor. But I am clueless about what is brain tumor other than it is some extra tissue in the brain. Hence, it becomes Type I ignorance which is safer because I am willing to seek help.

For your information, there is no such thing as Type I and Type II ignorance. I coined it myself and label it as Wilfred’s Theory of Ignorance.

However, it can be seen that these two types of ignorance is very real. I am very concern with Type II ignorance because it is like gambling with one’s life. I want to cite two examples of Type II ignorance I come across frequently.

First example: Once in a while I will come across clients who put 99% faith in their group insurance. The group insurance can be from their group employment benefits or those from the military/home team etc. They will buy a very high sum assured in other to protect their family. This is Type II ignorance because I found that they were not aware that the group insurance is not guaranteed renewable and most importantly the Master Contract is owned by the corporate entity. Thus, the life assured does not own the policy. All my clients who heard this got a shock as to why they are not the direct policyholder. The implication? The security of their family is no more guaranteed since these policies are not guaranteed renewable. Thus, this is Type II ignorance. After they heard me, it becomes Type I ignorance because they will ask me – what is the heck is the meaning about group insurance and why such insurances were invented? But now it is safer because these clients were able to ask intelligent questions to clarify their ignorance. Thus, Type I ignorance is always safer and can be deal with easily.

Second example: Many people think that getting a life insurance is all about financial planning. Not too long ago, I spoke to a person about estate planning but she said that her life insurance agent will handle all claims if she or husband dies. Apparently she thought estate planning is about insurance agent claiming! I almost burst into laughter but of course being a gentleman I controlled myself and laughed after the meeting privately until I almost felt off the chair (OK, enough of me making fun of others…). Still, I found it so amusing. This is what I called Type II ignorance. I then told her that estate planning isn’t about life insurance agent claiming for death benefit. She become defensive and just mentioned that they will not do estate planning. I think it was because I pricked her ego revealing of her Type II ignorance. This reminds me that a person with Type II ignorance can potentially be detrimented by self pride. Anyone who attempts to correct a Type II ignorance runs the risk of hurting the ego of such a Type II ignorant person because it makes a person looks very very silly.

I want to say some more about Type II ignorant relating to more serious matters. The reason why many clients do not take legal action against their financial advisers for selling an unsuitable product is because the client will look like a fool in public. I know of clients who were taken for a ride for buying unsuitable products amounting to hundred of thousands of dollars in opportunity cost and yet they did not want to take legal action because of “face” problem. You see, when lawsuit is made in the open court, nothing is confidential. Thus, clients will have to admit that they were foolish to believe in the financial advisers’ sweat talk. Thus, clients may feel that they will be laughed at by their peers. The situation gets worst if these clients are professionals, businessman and even lawyers! Everybody takes pity on an old lady being ripped off of her life saving. But I am afraid to say that the public is unlikely to take pity on say medical specialist from being ripped off.

Another Type II ignorant that I encounter occasionally is the perception that most financial advisers work for free. But what many clients do not know is that they pay about $6000 - $10,000 in embedded commissions just for some silly plan of $500 monthly premium. This is because they are being locked into the plan for many decades. The lost of liquidity is able to generate a large commission upfront. But what the client gets is a liability in terms of committed cash flow. In the market place now, it is easy to generate an upfront commission of nearly $12,000 just for a “$1000” monthly RSP. I’ll not elaborate further otherwise I will get lawyers’ letters. Such huge fees are become a standard rate that clients pay from the embedded commission. But what do they get in return? Nothing except form fillings. Do they get advice on insurance? No. Tax planning? No. Investment planning? No. Estate Planning? No. Everything also did not get but they pay so much. I pity this group of individuals because they pay so much and got nothing except liability in return. Some of my peers asked me why I am so confident of charging an average of $5000 for each case. I often told them this: How much is the Product X (a common product these days) paying in commission? After some calculation, they figured that my fee is only half of it. But actually, the real cost of the product is not $6000, $10000 or $12000. It can be up to $400,000 in liability. How come? If the product manufacturer use 3% of the product in commission, the product’s revenue must be 12000/0.03 = $400,000. This revenue to the product manufacturer need not be a lump sum investment but it can be the present value of future committed cash flow. From the client’s balance sheet point of view, this appears as a liability. The liability is to be committed to a constant cash flow to a non-liquid investment product. This is to the extend how significant Type II ignorance can destroy a person retirement altogether.

In response to Type II ignorant, some people will do their own research for their own financial planning. I think this is very good because any attempt to do self research potentially can change Type II to Type I. Unfortunately life is a bit complicated. Much of the “free” research can be found on Internet only and these information cannot be verified to be correct. Take for example, if you search on valuating a swaption, you may be able to find some information but do you think the information is true? How to verify? So you would try to find a second source and a third source and a fourth source, etc. But there is a chance that all sources copied from each other. The time a person can “DIY” for a simple matter is probably not much. But there are some aspect which is not worth spending so much time all. The worst thing is that the person never knows whether is it correct or not. Such a person may be able to seek help from “free” financial adviser. But as I mentioned, each “free” financial adviser will try to sell his product in subtle ways. Of course, every financial adviser will say everybody else is lousy except himself. So the “research” gets polluted by wrong advice and wrong information.

Seek advice only from professionals who can upgrade you from Type II to Type I. Contact me only if you wish to have the upgrade. Those who are seeking for free advice need not bother.

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