An investing rule of thumb
When it comes to investing, I have a personal rule of thumb:
If someone offers a high guaranteed return on an investment, I walk in the other direction.
Bonds issued by Governments or reputable institutions are okay.
But high returns, nearing 10% or more? I start to run. If I don't vomit first.
Life is uncertain.
When it comes to the big things in life, nothing’s guaranteed.
At the individual level, we don’t know how long we’ll live or what our health will be. We can’t predict the twists and turns of our careers. We don’t even know what the world will look like in 30 or 40 years – the social, technological, environmental, and political possibilities are endless.
As the saying goes: “we plan, God laughs”.
That doesn’t mean that planning is useless. As Eisenhower said: “plans are useless, but planning is indispensable”.
It’s the same at any level. In professional settings, there are usually a limited number of ways in which a project can go right, and a million ways it can go wrong.
Ask me to make a prediction, and in most situations I’ll say: “I don’t know”.
I’m usually happy to make a probabilistic prediction – ie, make a prediction and express a degree of confidence behind it, with the proviso that all of my predictions are subject to change when new information becomes available.
When people express certainty, my immediate response is:
To my mind, this is exactly what is happening when someone offers a guaranteed or fixed return with a high rate of return.
I’m philosophically opposed to this type of certainty. I’m not going to put my money with someone I’m at fundamental odds with.
Good faith attempts haven’t worked out
I was sad to hear that Lifetime Retirement Income recently mothballed its Guaranteed Income product.
This appeared to be a genuine, good-faith attempt to guarantee an income for investors, and provide their clients with financial security in their twilight years.
I’m not especially surprised that this happened (see my 2018 article). However, I’m surprised it happened so quickly. One part of me is relieved, because I would have hated to see it be mothballed after people had been paying insurance premiums of 1.3% per annum for a decade or more.
What is noteworthy is that Lifetime Retirement Income offered this guarantee in all the “right” ways. It offered this fund to retail clients. It subjected itself to scrutiny as well as regulation by the Reserve Bank that it might not otherwise have had to deal with it had offered its product in a different way.
Lifetime Retirement Income initially guaranteed a lifetime income of 5%. This reduced to 3.5%. Even at this reduced level of income, it appears this product wasn’t sustainable.
I’m excited regarding what Lifetime tries to do in the future. But it’s a good example of guarantees not being guaranteed... even at fairly low rates of return.
Who is offering the guarantee, or standing behind the fixed returns?
The Guaranteed Income product was guaranteed by a company that was regulated by the Reserve Bank, which set capital requirements for the fund. The Reserve Bank doesn’t have a crystal ball, but it’s an independent arbiter, and almost certainly would have set rules that prioritised the interests of investors in the product. In the scheme of things, this is pretty solid.
Arguably, the closest you can get to a “risk-free” or “guaranteed” return is what is offered via Government bonds. This is because you’re dealing with Government. When a Government of a developed country owes you money, you can be pretty confident it’ll pay you when that debt is due.
Governments always have the option to tax more or print more money. That’s as close to a guarantee as you can get.
This is the reason Government bonds don’t tend to generate great returns. Because when you invest in this way, you’re not looking for return on capital: you’re looking for return of capital.
Yet we have organisations advertising fixed or guaranteed returns that are much higher.
A couple of years ago I wrote about Gavin de Becker’s book The Gift of Fear. That book still sticks with me, and excerpts come to mind quite regularly.
For instance, he explains that “Always, in every context, be suspicious of the unsolicited promise.” He describes the unsolicited promise as “one of the most reliable signals because it is nearly always of questionable motive”.
“Promises are used to convince us of an intention, but they are not guarantees. A guarantee is a promise that offers some compensation if the speaker fails to deliver; he commits to make it all right again if things don’t go as he says they would. But promises offer no such collateral. They are the very hollowest instruments of speech, showing nothing more than the speaker’s desire to convince you of something.”
I sometimes wonder whether these “guarantees” are really guarantees, or more like promises as described by de Becker.
What are the nature of guarantees being offered by these private organisations offering higher returns?
When you look at the small print of these sorts of investments, you might find some vague information about the guarantees.
Personally, they don’t fill me with confidence.
It’s not uncommon to see that the fund is guaranteed by one or more individuals, plus one or more corporate entities. Sometimes you’ll read about one or more of these entities having an equity base of one level or another.
I can’t speak for the individuals who are prepared to satisfy these guarantees. But I can speak from my experience as a lawyer who used to advise people in relation to asset protection. Granted, it has been a while. I have probably forgotten more than I remember.
In a situation like this, my first instinct would be to suggest that anyone offering a personal guarantee like this hold very little personal wealth to speak of. From their perspective, it would be prudent for their assets to be structured in a way so that if the guarantee was ever called, there would be nothing behind it.
What about a private entity which holds a certain level of equity at a certain point in time?
For one thing, how much income is this entity guaranteeing? An equity base of, say, $10 million isn’t much if you’re guaranteeing $10 million of investment income each year.
Nor do we know anything about the nature of that equity. For example, is it liquid and accessible, or would it require selling a property or development-in-progress? If the fund started struggling to repay the guaranteed returns, is it possible that the value of that equity would reduce?
Personally, I’d give very little credence to guarantees or fixed returns of a high level.
I’m not saying that this is the case with anyone offering these guarantees. I don’t know enough about any individual offering to make that assessment. All I can say is that’s my starting point.
When I hear guarantees of high returns, my initial response is scepticism.
I can’t make any guarantees, and I won’t tell you what will happen. But if you put your money with an organisation that makes offers like this, there’s a good chance you won’t get the return you expect. There’s a chance that you’ll also lose some of your capital.
While I’ve got your attention, I have a special offer.
If you want be in Brad Pitt’s next movie, flick me $1,000, and I’ll arrange a speaking part for you.