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No easy way to make money

There is no easy way to make money. There are no shortcuts to building your retirement savings. Do not convince yourself otherwise.

This week, the ABC reported on yet another trading programme which appears to have lost lots of money for the people who signed up. The alleged culprit is 21st Century Eminis, which provides financial education and training services on how to become a successful trader. There is little in life that frustrates me more than to see people lose their hard earned savings on get rich quick schemes.

I have long been outspoken on this topic, including making submissions to ASIC and posting public notices on my advisory business website warning against such schemes. Unfortunately you have to be careful about how you word such public notices for various legal reasons. Simply put, whenever you are introduced to a scheme or an investment opportunity which sounds exciting, please repeat: “There is no easy way to make money”. If you know a family member or a friend who is considering such an opportunity, say to them with passion: “There is no easy way to make money”. It may be one of the most valuable things you ever do for them.

Retail investors are sometimes shown four possible shortcuts to financial success, each having a different path to potential failure.

1. Investment products which turn out to be fraudulent

A great (though ‘great’ is far from an apt description) example is Astarra (Trio was the trustee) which funnelled investors’ money offshore never to be seen again. Worse still, Astarra products were recommended by financial planners. Another example is US-based hedge fund Madoff, the largest investment fraud ever seen.

Fraudulent schemes are highly likely to lose you money. They typically have an elaborate design and structure and the payoffs for a successful fraud can be huge. The Madoff hedge fund fraud is estimated to have cost US$65 billion. If a fraud is cleverly designed it is extremely hard to identify. Before making any investment, you should undertake a thorough due diligence. If you are considering an investment then seek professional advice. Question the skills of your advisor and make sure the advice is truly independent. Astarra, for example, sponsored financial planning conferences and Madoff supposedly provided access to a network of high profile people.

Commonly, frauds promise outsized returns but some of the recent frauds (including Astarra and Madoff) only targeted good solid returns, thereby avoiding people’s fraud radars. Finally, diversify – it sounds simple but unless you are so confident you have identified something truly amazing and unique (which is unlikely), then diversification makes sense. Question your own skills. Are you really someone who can identify the needle in the complex investment haystack?

2. Investment products which involve leverage

The underlying assets of these investments vary but the constant theme is leverage. Infamous examples here include Storm Financial (leveraging up equities, and in some cases leveraging up leveraged equity funds), or investors providing leverage to property businesses (Westpoint, MFS Premium Income Fund, City Pacific and EquitiTrust). Once again many of these investments were recommended by financial planners, possibly swayed by large commissions.

Leverage has its place in the hands of professionals. In theory leverage has a proportionate effect on risk (an investment in a risky asset with a volatility of 10% combined with a 200% exposure to this asset becomes a leveraged investment with 20% volatility). However in practice the risk created by leverage is much more complex because there are many other risks that come with managing a leveraged product such as maintaining the leverage ratio or margin requirement, particularly in periods of market stress when the underlying assets may be volatile and illiquid. For any investment it is important to determine if leverage is used, how much is applied and explore any risks that may result. If this is too complex for you then stay away. Leverage does not always guarantee disaster but it does create greater risk of disaster.

3. Trading programmes and software which fail to deliver

This takes the form of software or training courses that teach you how to become a successful trader, often promising large financial returns and even the potential to give up your day job and become a home-based trader.

With trading programmes (software and education) I maintain a high degree of scepticism. After 17 years in the investment management industry and having visited thousands of investment managers and hedge funds I know it is difficult to develop a set of trading rules guaranteed to perform. If someone did find something special do you really think they are likely to share this with the world? Surely they would either trade their own money or create a hedge fund to earn the associated performance fees. Either of these approaches would also protect their trading secrets.

While there is much debate among academics about whether markets are efficient or not, I work on the basis that markets are broadly efficient. I believe that simple models will fail to generate outsized returns for the risk taken, a point I have proven to myself (and my uni students) many times! Many trading programmes use underlying instruments with embedded leverage such as futures, margin FX and CFD’s (contracts-for-difference). These instruments are dangerous in the hands of the uninformed. If you do not understand them then do not touch them.

4. Tax-driven investments

This is where tax benefits are a major driver of the investment outcome. Agriculture schemes, most notably Great Southern and Timbercorp, are the most prominent (read painful) recent experiences.

Tax-driven investing can be complex. The risk is that chasing a tax objective may lead to money being placed with people ill-equipped to handle the day-to-day business of managing the assets and finances of the investment vehicle. If the business activities are mismanaged, then the investment vehicle may not survive to provide any tax benefits at all.

Always be wary of terrible governance practices. Prime Trust is a distressing example where exorbitant payments were made to the founder. While poor governance can exist anywhere there seems to be a greater risk away from mainstream investment opportunities.

I hardly paint a pretty picture for get rich quick schemes. Really, none of this article should be new information. If it is, then you are vulnerable to these risks. If you are presented with an opportunity that looks really exciting, make sure you remind yourself that “There is no easy way to make money”.

 

In July 2014, David will cease his independent consulting and become the Chief Investment Officer at AUSCOAL Super. He teaches the Hedge Funds elective for Macquarie University’s Master of Applied Finance.

5 Comments
Patricia
June 19, 2014

Dear David, very well put. I hope we won't lose the benefit of your insights come July when you take up your new role.

Jerome Lander
June 17, 2014

I would add that fraudulent listed companies represent an opportunity for talented investment managers to make money on the short side, precisely because frauds are not routinely recognised as such by most investors. As you state, frauds are highly likely to lose money and that in itself represents a great opportunity.

We happen to have one of the best investment managers that uncovers frauds in Australia and readily accessible to Australian wholesale investors. Their Chief Investment Officer is the very same person that uncovered and first reported the Astarra/Trio fraud. Instead of being burnt by frauds, investors can in fact profit from them and help contribute to a better marketplace at the same time.

I have been working to help people become aware of this precisely because it is such a valuable opportunity for investors.

LAKB
June 17, 2014

When a fraudulent company is discovered or suspected I would hope the priority is to report it to the authorities before profiting from it.

Hugh Dive
June 16, 2014

Great piece David. What I find most disturbing is that the individuals often targeted by the promoters of the above 4 styles of money-making products are those that can least afford to lose money.

David Barr
June 14, 2014

This article should be published on the front page of all national and financial newspapers

 

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