With total losses from unregulated investments in 2019 about to hit £1 billion by my count, this seems an appropriate time to debunk a couple of myths that are commonly believed about the victims of unregulated investment schemes which collapse and lose their investors’ money. Not least by the investors about themselves.
Myth #1: The victims of collapsed investment schemes were greedy
In the HYIP world of schemes offering returns of 1% a day or double your money in a year, this is arguably true.
However this isn’t a blog about HYIPs (there is enough coverage of those already). This is about unregulated investments offering yearly returns which are most commonly in the region of 8%-10%. They are occasionally higher but they can also be as low as 5% or even lower.
These returns are not set in the way that mainstream investments set their returns. It is not a question of supply and demand. The return needs to be high enough to tempt investors away from cash accounts and mainstream investments, but not high enough to automatically scare them off thinking “too good to be true”.
The evidence of the last ten years shows that the sweet spot is somewhere around 8% per year. Some collapsed schemes have offered lower and some higher, but 8% is the median.
Returns of 8% per year have been achievable – though not guaranteed – from mainstream, diversified, non-geared capital-at-risk portfolios.
Since 1991, the average return from a diversified, non-geared portfolio of 80% global equities and 20% bonds over a 5-year period* has been 8.15% per year.
Investors in that portfolio would be spread across thousands of shares and bonds worldwide and would have minimal risk of losing money in the long term, unless they cashed it in during a low point due to panic or poor planning.
That does not mean that anyone investing in mainstream equities can expect a return of 8%. Over that timeframe, the chance of getting better than 8% in a 5-year period was little better than a coin flip. In 55% of 5-year periods, the above portfolio did better than 8%; in 70% it did better than 6% and in 87% it did better than cash.
What it means is that the idea of an investment which has a potential return of 8% and minimal chance of losing all your money (providing you can hold for the long term) is not too good to be true.
“But it’s still greedy to expect a return of 8% from a supposedly guaranteed investment.” True. But many of these investments aren’t described as guaranteed. They have risk warnings all over the place. But the risk warnings are presented in such a way that inexperienced investors are encouraged to ignore them. And the people selling them over the phone will say things like “that’s just something we have to include because regulations, don’t worry about it”. Of course, once the investment has collapsed, these phone conversations never happened.
“But it’s still greedy to expect a return of 8% from an investment that’s only 3-5 years – a capital-at-risk investment needs to be held for at least 5 years, preferably 10 to expect inflation-beating returns”. Investors are almost never hoping to put their money in for three years and then take the money out and spend it all. Nobody invests in this kind of scheme just so they can turn £10,000 into £10,800. They are most commonly investing either money that has been accumulated in cash for many years, or a windfall (e.g. inheritance or pension lump sum) which they do not expect to spend in the immediate future. They typically expect to carry on investing for 5 years or longer – and if their investments pay out after the agreed term, they often reinvest.
It is true that returns of any level can never be guaranteed in the future – and certainly not 8% per year. The FCA currently considers 5% to be a reasonable “mid-range” expectation for standard stockmarket investments.
But the crucial point is that if it is greedy to think you can get a return better than cash without risking the loss of all your money (in the absence of total financial collapse), all of us are greedy.
The mistake the victims of collapsed investment schemes make was not to want a better return than cash without losing all their money, but trusting the wrong people to deliver it for them.
Which leads us neatly to Myth no. 2.
Myth #2: The victims of collapsed investment schemes were stupid
Or foolish or naive or whatever word you want to describe a person who picks the wrong person to trust.
If I spar with a black belt in jiu-jitsu and he repeatedly dumps me on the mat, does that make me a weakling?
Naturally not. I might be in great physical shape. But I’m up against a guy who has been sparring with other people for years, who knows exactly how to manipulate another person’s body and has practised his techniques to the point they are second nature. I should expect to be dumped on the mat. That doesn’t suddenly turn me into a weakling.
The people who run and market fraudulent unregulated investment schemes live by persuading investors to part with their money.
They have been doing it for years. Their survival and their lifestyle depends on it.
They know all the moves, they know all the techniques, they know how to exploit cognitive bias. They know every question an investor might come up with and they have an answer for all of them.
They are black belts at turning investors’ minds against them.
Not all the people behind collapsed investment schemes are particularly intelligent, just as their victims are not particularly stupid, and thousands of jiu-jitsu black belts are physically average. But it is what they are good at, and being good at it does not require being particularly smart.
This is a question of technique, not intelligence. Investors have been outsmarted, but that does not automatically make them stupid.
Being financially inexperienced or naive is not a crime, and does not deserve to be punished with the loss of all one’s money.
*Source: Portfolio consisting of 80% FTSE World TR and 20% Bloomberg Barclays Global Aggregate Bond. Average 5 year return is the average of the return over the 8,781 complete 5-year periods spanning 1-1-90 to 15-1-19. To be strictly fair we should knock around 1% off the index returns for charges, but as unregulated investments are frequently promoted with terms like “No fees or charges”, I’m not in a strictly fair mood.