There was an article published here: It's Better To Get Your Hands Dirty. I would like to comment on (1) Scam and (2) Friendship
It has been said that if an investment product is too good to be true – than it probably is. If a product can give 50% guaranteed over 2 years (for example), look no further as this is definitely a scam.
Why? It is important to understand the meaning of the word “guaranteed.” In the financial jargon, the word “guaranteed” and the English word “guaranteed” does not have the same meaning. While the English word “guaranteed” means “certainty”, the financial jargon “guaranteed” simply means a contractual obligation by a counterparty to deliver the promised return. Does it mean that if the return is contractual in nature, it means it is safe? No I am afraid not. While the counterparty can be a person or an institution, if the counterparty breaches the contract, in financial jargon it means that counterparty defaults. If the counterparty defaults, investors can sue. However, if the counterparty is already insolvent (meaning its asset is less than liability), than depending on what kind of “creditor” you are, you may or may not get anything back. Even if you could get something back, it may not be your entire promised amount. After netting off legal fee, you could actually be getting nothing or even incurring more losses for pursuing legal recourse. That is why, if the amount is not extremely large, most investors would not seek legal suit to get back their money when a counterparty defaults. Therefore, does it mean that the word “guaranteed” return carries no meaning in the financial world? Not really. If the counterparty is highly reliable and reputable, than the word “guaranteed return” carries more weight. For example, if a bond is issued by the Singapore Government Bond, the guaranteed coupons and repayment of par value on maturity has the same meaning as the English world “guaranteed return.” On the other hand, if the counterparty has a “C” credit rating, this means that the issuer is likely to default. Thus, this counterparty is not likely to deliver its promise. In this case, the word “guaranteed return” is as good as no return.
Many scam play with the word “guaranteed return.” Technically, it is true that they “guarantee” their return of 50%pa over 2 years (figures for illustration only). However, chances of defaulting on their promise is also guaranteed (no pun intended.) This means that the counterparty will certainly default on their promise. If the counterparty will certainly default on their payments, then the seller or the introducer is selling you a scam. For reference purposes, the current risk-free return using Singapore Government Securities for a 2 years maturity time frame is 1.46% yield to maturity. Thus, any investment which “guarantees” its return over 2 year time frame should not have a return too far from this reference. Thus, if the guaranteed return is 2% pa (for example), it is realistic. If the guaranteed return is 20%pa over 2 years, it is a scam and a police report should be made immediately.
Scammers will play on the emotions of unsuspecting individuals. The most common is a Ponzi scheme. Let’s say you were asked to invest $1000 and promised $125 per quarterly payout. This works out to be 125*4/1000 = 50% in current annual yield. The figure already shows this is a scam as it is too far from the reference risk-free return mentioned above. But to trap the investor, the scammer will actually give out $125 quarterly to the victim for a period of time. The victim will be convinced it works and hence would likely invest more money and introduce others into the scheme. How does the scammer give this money? It is easy: the money that is given to the victim comes from future victims. However, future victims’ need to be given this high payout as well and hence their payouts come from future victims too. Soon, a very large pyramid is formed in which the top of the pyramid benefits but the last to join the pyramid will be the one to suffer. Eventually the pyramid will collapse due to cash flow problem as the rate of recruiting future victims is not fast enough to pay the pioneer victims. Due to increased knowledge and information availability, many so-called “victims” knew all along that they were participating in a scam. But their hope is to benefit from the scheme before the pyramid collapses. Thus, some “victims” are not that innocent after all. This is dangerous because future victims could sue earlier victims. That is to say that the “victim” could end up be suit by other “victims.” Therefore, it pays not to participate in a scam. If in doubt, do not invest in it.
Is it true that scammers work in the dark alley ? Unfortunately no. Many scammers give seminars in reputable hotels. Other scammers have registered offices in Singapore. Far from working in the dark alley, these days scammers are out in the open. Examples of well-known scams (all of which are ponzi scheme) are:
Sunshine Empire – See articles: http://en.wikipedia.org/wiki/Sunshine_Empire and it is on the MAS Alert list too.
Powder River Petroleum (through OilPods) – See newspaper appended to this blog. Also see links compiled by my colleague HERE
Certain land banking – See research done in this link HERE
Were the above only available in the dark alley? No, far from it I saw all of the above in the open. Some were actively selling their products in exhibitions and some were openly having seminars in hotels.
In the newspaper article, it said that 47% of wealthy women sought the investment advice of friends and family while 38% of men sought advice from their peer group. This means that there are a huge group of unregulated investment advisers giving advice to their friends and relatives. Here are some of my thoughts to this:
Many people who give informal advice to friends and relatives do not realized that they could actually be committing a crime under the Financial Advisers Act. Under the Act, anyone who gives investment advice has to be regulated by the authority. Sometime they give advice privately while other times they give very specific advice publicly such as their blogs. Usually if there is no lost of money, all things will be well. But if someone losses money, a lawsuit can happen and there goes that “friendship.” Thus it is not worthwhile dispersing investment advice even to one’s own relatives and friends. There is nothing to gain but everything to lose. Besides, no advice can give guaranteed return and so why bother to give advice when there is absolutely nothing to gain but only acquiring liabilities?
For those who like to seek investment advice from peers cited “trust” as one reason. But really, I think this a misplaced trust. It is not likely that the advice will be better off than a professional adviser. Besides, if a person is really savvy in his investment knowledge and skill, he or she will be fully aware that he has everything to lose and nothing to gain for giving advice unless he is regulated person. Thus, such a person who is savvy in investment knowledge would not give out any advice anyway. The one who is truly savvy (and at the same time not a professional advice) would likely just keep quiet and do his own things making money for himself. But does it mean that professional adviser is likely to do better? I am afraid that is not necessary. We live in Singapore and know the real world. Over here, many professional investment advisers are professional hardcore salesmen with the professional skill to force shaft a product down an investor’s throat. It is also not necessarily true that the rich will have more access to better “quality” advisers. I have seen rich clients who had bought into CDOs and related toxic waste. Looking at the value of these toxic waste now, I do not think they are high networth already. All thanks to their professional salesmen who is more keen into pouring toxic waste down their clients’ throat and enriching themselves with high commissions or year-end bonuses.
End of the day what should investors do? How to avoid scam? And how to avoid professional salesmen? How to avoid the bad advice? The key is self-educating. Everyone must educate himself or herself in financial matters. There is no need to become expert in financial matter but the basic must be learnt. For example, if a guaranteed return of a product is 50%pa, it is definitely a scam. Not too difficult right? If a product is hard to understand and has no logic, it could be a scam too.
Moreover, investment is not difficult. Just RSP into index funds and buy and hold long term. That is all. Boring stuff indeed.
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