Never get caught by investment scams again - arm yourself with knowledge

Never get caught by investment scams again – arm yourself with knowledge

We all want to get rich quick! There isn’t anyone out there, if given the option, who would choose to earn a million over 20 years rather than this year. Right now. And that’s the attraction of each and every investment scam or pyramid scheme – more money and much faster than a conventional investment.

The sad reality is that in times of economic uncertainty people tend to be desperate for an improved income and allow themselves to be fooled by information which seems feasible (but not easily understood).

So how do you know which investment schemes are legitimate and which are not? It’s easier if you understand how investments work and know what historic returns have been for each investment class. If a return looks too good to be true – it usually is.

Let’s start by defining investments

 Most investments fall into the four basic asset classes, namely:

·         Property

·         Shares

·         Cash

·         Bonds

 

(There are less common specialist areas; collectables, precious metals & commodities, but they are for specialists. Let’s face it – if you are approached by a shady diamond dealer, you know you are looking for trouble!).

 

Every investment has components of these underlying asset classes (if not directly invested in them). For example: If you have a townhouse in your name that is rented out, then you are directly invested in property. However, if you own a Property Unit Trust, your investment would be a unit trust fund and the underlying asset class would be property. If you held a unit in a Property Syndication, then the unit held is your investment, not the underlying property. This means that when you sell your unit no property (title deeds etcetera) transaction takes place.

All of the four basic asset classes are available within products such as unit trusts, endowment policies (sometimes included in your life insurance, sometimes called “savings plans”), wrap funds and so on.

Let the broker realise that you know what you are talking about

If confronted with a fancy name for an investment, ask what the underlying asset class (or mix of classes) is. Don’t let the investment broker baffle you with “bull dust”. Make it clear that you understand how all investments have an underlying asset and you want to know what it is.

Each asset class has an average expected return over time. Yes, in the short term assets can do much better (or much worse), but they will always incline towards the “normal” return over time. So what is the long term average of each class?

It depends on what you call long term – 10, 20, 30 or 40 years. In each time period the average will differ. It also depends on which 10 or 20 year period is illustrated. Was it before the last stock market crash or just after? Generally speaking though, over the very long term the ups and downs balance out.

Average investment returns

We can assume a return of about 16%pa for shares, 15%pa for property (property returns have improved greatly over the last 10-15 years with the advent of property funds and unit trusts which act a lot like shares; and the SA property boom, which cycle came to a sticky end not so long ago), 10% for bonds and 7% for cash. This is before inflation is taken into account.

So if an investor offers you “interest” of 20%pa indefinitely you must realise it’s not sustainable, as around 10% is the long term norm. If interest rates of 18% are being offered by the banks on cash at that time (this has happened in the past, believe it or not!), then 20% is not such a stretch in the short term. You would then ask the investor how they get better rates than the bank and expect a clear answer. Then get a second opinion on their explanation.

Now read the following excerpt from a local newspaper:

“A couple was arrested in Polokwane on Thursday for running a pyramid scheme, police said.

"Clients were requested to invest about R21 000 each, which they were promised will accrue R108 000 within a period of few months," said Lieutenant-Colonel Mohale Ramatseba.

Victims were thought to have been swindled out of millions this way.

The 28-year-old man and his 25-year-old wife were accused of practicing a pyramid scheme, operating a financial business without a license and money laundering, said Ramatseba.”

Can you see that the returns offered are ridiculous? And yet thousands of people bought into this scheme. Thousands of people do not know how investments work and what type of returns to expect.

Don’t be fooled by seemingly generous payouts

If friends or acquaintances have invested in the scheme and been given the returns promised (often only monthly income, not capital returned) it does not mean that the scheme is working. It means that more people are investing so there is enough money to pay out per the promises. If the new cash acquired is being used to pay the previous investors, how can it be invested to earn the promised return? It can’t be. As long as new people are buying in at a rapid pace and the investor base is still small, payments can be made. As soon as there are more investors to pay than new people buying in the whole scheme will collapse.

There is a term for investing money and hoping for unbelievable returns. It’s called gambling. The same rule as applies to gambling applies to investing in schemes that seem too good to be true – can you afford to lose the money that you are offering up? If not, stick to the conventional investments. And, as always, get advice from accredited people who you can trust.