A 20% return guaranteed: fact or fiction? – Moneyweb.co.za

You only have to consider the many scams throughout history – such as Charles Ponzi’s original 1920s creation or, in the more recent past, the likes of South Africa’s Fidentia investment scam – to appreciate that 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, of course, extremely appealing. The question is: how do we distinguish between scams and sound investment options with solid returns?

The key point to bear in mind is that there are only a finite number of instruments in which you can invest your money in order to earn an income. While products may change and receive a face lift over time, the underlying fundamental asset classes in which you invest – and which drive your returns – do not change. So, if someone offers you a guaranteed 20% to 30% return, but you know that realistically they will only be able to earn a 13% return given the stated asset class (more on that 13% later), you know they must have an unsavoury method of making up the substantial difference of 17%.

While scams come in various forms, they frequently make up the 17% shortfall mentioned above by giving you someone else’s money. For example: Mrs First Victim invests R100 with her ‘investment advisor’, Mr Ponzi. Mr Ponzi promises her 30% returns per year. In order to achieve just a 13% return (R13, in this case) in the stated asset class, Mr Ponzi will need to invest that money for a long-term period. Now Mr Ponzi needs to find R17 in order to give Mrs First Victim her promised 30% return, otherwise the scam falls flat from the start.

Enter Mr Second Victim, who also wants to take advantage of this wonderful opportunity. Mr Ponzi takes the R17 he needs from Mr Second Victim’s R100 and gives it to Mrs First Victim. Now she is happy with her 30% return and tells all her friends, and Mr Second Victim looks forward to his amazing returns. Mr Ponzi’s problem now is that he has only R83 left of Mr Second Victim’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 Ms Third Victim’s R100 investment. And so the cycle continues and Mr Ponzi’s problems escalate.

The moment new inflows don’t meet Mr Ponzi’s distribution needs (either because regulators have intervened or investors get suspicious), the whole house of cards comes crashing down. So, why is it not possible for Mr Ponzi to legitimately invest your money and generate a 30% return per year?

An appetite for risk?

Well, as indicated previously, there are a finite number of asset classes in which you can invest in order to give you a return on your money. These range from conservative cash investments in a bank to shares on the JSE. Every asset class has a risk/return profile. If you want a low-risk investment, you must accept a low return. If, on the other hand, you are willing to take on more risk and invest in the stock market, for example, you will get a higher rate of return, but you will experience more volatility during the process and will likely need to commit your capital for a seven-year or longer period in order to realise those returns.

In between the extremes of low-risk cash and high-risk equities lie the asset classes of bonds, property, hedge funds and the like. A direct stock market investment, which is on the risky side of the spectrum, has provided an average return of 13% over the long term. Of course, there will be years of 20% returns or more, and years of significantly negative returns, such as those experienced during the 2008/2009 financial crisis. No one knows for certain which shares within the stock market are going to generate the best returns. The safest way to ensure your money generates a return above inflation is to diversify your risk and hold shares in different companies, in different sectors, in different countries and even in different currencies.

Getting the mix right between asset classes and ensuring that you have a nuanced understanding of the inner workings of options within such assets, takes skill and deep investment knowledge. Someone with a financial background, say in tax or property, and wearing a nifty suit and an expensive tie is not necessarily qualified to give the sort of sage investment advice you need to navigate this complex world. Only engage with a financial advisor who is a registered representative of an authorised financial service provider company and who is authorised to give financial advice. If a person does not meet these criteria, then walk away.

In conclusion

While we would all be happy to enjoy a 30% return on our money, the old adage ‘if it sounds too good to be true, it probably is’ rings true. Investment fundamentals don’t change overnight, and investing is not a one-day game. Start saving and investing at an early age, guided by the advice of a qualified financial advisor to help you along the way and you will reap the benefits over time and, ultimately, reach your financial goals.

Pierre Muller is Citadel’s advisory partner.

This article was first published in The Citadel Investor 2017 here.

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