Guaranteed yields: is it fact or fiction?

LIMITED CLASSES: BEWARE OF INVESTMENT SCAMS

How to distinguish between scams and sound investment options with solid returns.

Meteorically-high yields often come with a catch. With consumers feeling the pinch of the current, challenging economic environment, the promise of such lucrative returns is extremely appealing.

But how do you distinguish between scams and sound investment options with solid returns?

There are only a set number of instruments in which you can invest to earn an income. While products may change and get a facelift over time, the underlying fundamental asset classes in which you invest – and which drive your returns – don’t change.

So, if someone offers you a guaranteed 20%-30% return, but you know realistically they’ll only be able to earn a 13% return, given the stated asset class, they must have an unsavoury method of making up the 17% difference.

Scams often make up the shortfall by giving you someone else’s money.

E.g. Victim 1 invests R100 with ‘investment advisor’ Mr Ponzi, who promises 30% returns per year. To achieve a 13% return (R13 here) in the stated asset class, Mr Ponzi must invest that money for a long-term period. Now he must find R17 to give Victim 1 her 30% return.

Enter Victim 2. Mr Ponzi takes the R17 he needs from Victim 2’s R100 and gives it to Victim 1. Mr Ponzi only has R83 left of Victim 2’s initial R100 investment from which he needs to generate R30. He invests the R83 and earns a 13% return, which gives an R11 return. So Mr Ponzi must now find another R19 to make up the difference, which he gets from Victim 3’s R100 investment. As the cycle continues, Mr Ponzi’s problems escalate.

When new inflows don’t meet Mr Ponzi’s distribution needs (e.g. regulators intervene or investors get suspicious), the house of cards crashes down.

So, why isn’t Mr Ponzi able to legitimately invest your money and generate a 30% pa return?

There are a finite number of asset classes in which you can invest to give you a return on your money, from conservative cash investments in a bank to shares on the JSE. Every asset class has a risk/ return profile. If you want a lowrisk investment, you must accept a low return.

In between the extremes of low-risk cash and high-risk equities lie the asset classes of bonds, property, hedge funds etc. A direct stock market investment, on the risky side of the spectrum, has provided a 13% average return over the long term. There’ll be years of 20% returns plus, and years of significantly negative returns. No one knows which shares will generate the best returns.

The safest way to ensure your money generates a return above inflation is to diversify your risk. The old adage “if it sounds too good to be true, it probably is” rings true.

Pierre Muller is Citadel’s Advisory Partner

This article was first published in The Citadel Investor 2017.

If it sounds too good to be true, it probably is