Consumer champions like ThisIsMoney and Money Box regularly report on people who’ve come unstuck with an investment scam, pseudo-bond, or other moneymaking scheme.
These media outlets do a good job highlighting dodgy financial advice – and outright scammers and crooks.
But too often it appears that neither the punter nor the journalist is aware of the investing risks that were being taking by these hapless members of the public, even when a particular scheme was legal.
Typically the victim – Phil, a 52-year old school teacher, Camilla, a 33-year old care worker, or Basey, a 19-year old student – doesn’t seem to have thought very hard about where they were putting their money.
They wanted easy gains, and they brushed aside any thoughts of investing risk.
I’m not saying there aren’t criminals after our money. Even the legitimate financial services industry has its sharks.
But we have to take responsibility, too.
As I look at the doleful portraits in a newspaper story about an investment scheme gone wrong – perhaps a ripped-off stay-at-home mum miserably holding a tomcat, and being hugged by a supportive but excessively bearded spouse – I have some sympathy.
But often only some.
Many people seem to spend more time deciding how to cast their vote for The Voice than they do thinking about investing their money.
And their aspirations can be crazy:
- “Sure, buying farmland for £10,000 that in two years will be worth £100,000 when it gains planning permission seems like exactly the sort of brilliant investment opportunity I deserve – and that should just fall into my lap via a cold phone call!”
- “I don’t know much about platinum mining in South Africa, but I like the sound of 15% a month!”
- “I work hard! Why should I accept 1% a year in a rip-off cash savings account when I can get this Triple Enhanced Gilt-Reinforced Trusted Society Bond paying 10% with just some technical small print about my capital being at risk?”
- “Better than Bitcoin? Make mine a double!”
Such foolishness makes it harder for the rest of us.
Perhaps even worse is their tendency to go all-in with their life savings.
Never go all in. Assume every investment can fail you.
I wouldn’t even put all my wealth into the behemoth of trust that is Vanguard.
Yet some of these people will apparently sign everything over to a stranger who knocks on their door on a Wednesday night.
One investing risk or another
I’m probably being mean. It’s often pointed out that people who fall victim to scams often do so because they’re otherwise sensible who didn’t realize they’d wandered into enemy territory. In other areas of their life they’re competent, and that breeds a complacency.
There but for the grace of the regulator go I, and all that.
Yes, there are people with a lifelong history of chasing unicorns and rainbows to a steadily impoverishing affect. I’ve met a few.
But other people were just trusting or naive at exactly the wrong moment. The world would be a sorrier place if it was only populated by grizzled financial survivalists like us (I assume every investment I make can fail) who are always looking over our shoulders.
Also, frauds are one thing, but the investing risks that catch people unawares are subtler. Often the promoter transforms a visible risk into a hidden risk, and the mark is none the wiser.
You remember my slightly tongue-in-cheek first law of investing?
“Investing risk cannot be created or destroyed. It can only be transformed from one form of risk into another.”1
And so Phil, Camilla, or Basey sees one risk, but ignores another:
- Scared of the risk of inflation, Phil invests in a higher-yielding offshore bond, not realizing it’s held in a different territory or that he can’t get his money out with less than 12 months notice.
- After reading about expensive markets, Camilla resolves to start investing in supposedly safer stocks like utilities for the steady dividend, but is oblivious to newspaper reports about tougher government regulation and politicians threatening re-nationalization.
- Terrified that High Street banks might go bust, Basey opens a peer-to-peer account and looks forward to a higher returns, but is surprised when struck by bad debts.
The fact is all investments are risky and can lose you money.
If you can’t identify the risk with an investment in advance, you shouldn’t go near it.
Types of investing risks
There really are innumerable ways for things to go wrong, so please see my bluffer’s guide to the main risks.
Then, next time you consider making an investment, think about which of these risks you’re taking, whether you’re comfortable with it – and whether there’s the potential for sufficient rewards to compensate.
Remember too that if something has an 95% chance of success, it wasn’t necessarily a scam if it fails. You could have just been in the unlucky 5% of dice rollers.
Risky business
The presence of risk does not mean an investment is a bad one. All investments have at least some risk.
What matters is whether price is right for the risk you’re taking, whether you can afford to take that risk, and whether you understand what you’re getting into.
As the great investor Charlie Munger says:
“Tell me where I’m going to die, so I won’t go there.”
Let’s be careful out there.
- I’m convinced I was first to coin this as a play on the law of thermodynamics, incidentally. I have recently seen it credited to someone else on the web who first used it long after me. Anyway, I am not ripping them off and I assume them not me. Great minds and all that! 🙂 [↩]
And then you buy irredeemable preference shares in a pension company like Aviva to generate pension income only to have them declare that they can redeem them at any time!
Yikes!, now you’ve got me thinking, I simplified my portfolio several years back when Vanguard introduced their LifeStrategy funds 🙁
Thanks for the excellent post TI.
I think a lot of the issue comes down to the regulators wanting the industry to speak about risk in a certain and specified way. Unfortunately, I find that language is abstract – it doesn’t get to the point like you said: “What matters is whether price is right for the risk you’re taking, whether you can afford to take that risk, and whether you understand what you’re getting into.”
My preferred definition of risk is that: “More outcomes can happen than will.” You can use this to work out whether the product works for you. First ask yourself: “What is my preferred outcome for this product”. So for a 5 year bond – “I’ll get all my coupons on time, and repaid the full par in 5 years”. Then think about what other outcomes can happen, some good, some bad. What if interest rates go up/down (interest risk), inflation goes up/down (inflation risk), the company goes bust (credit risk) and so on. By turning the risks into real things (rather than percentages) it makes it much easier to understand whether that risk is affordable and worth taking.
Whilst I have some sympathy for the vulnerable elderly who get scammed, on a week like this, when I’ve spent a total of probably 4-5 hours on the phone and visiting banks with ID to resolve their fraud check false alert account blocks, my sympathy is lower than usual. Not so long ago, before every fool and his dog started doing online banking and then sending all their savings to a random cold caller, it was all so much easier.
I suspect many of these people who get caught out will be those who are not well educated, do not have a degree for example and are lacking in financial sophistication or savvy which many Monevator readers take for granted. They probably rely on those they perceive as better educated to guide them in the right direction and many are let down time and time again.
“Better than Bitcoin? Make mine a double!”
Funny indeed. I have some smart and successful friends who are falling into this “irrational exuberance” type of speculating mindset. Sigh
@AF – haha – I have a mate who’s bright (postgrad level) but at the same time not so savvy with his finances. I use him as a barometer, immediately discounting following suite but seriously considering doing the opposite whenever he announces his latest wheeze. He ploughed into crypto just before Christmas.
I am *very* cognisant of being too reliant on vanguard and too few brokers. I am hoping for an article on how to diversify away from such a scenario without creating too much additional admin. I’ve mulled it over for years but its not that easy..
So am I being stupid having 7 figures spread across ISAS, SIPPS and taxable, for wife and I, all in vanguard all world etf all in Hargreaves Lansdown?
There is so much psychology at play here, I know several people who’re more financially savvy than the average [granted that bar is set on floor level & you just have to not trip over it] & have jobs doing things I can’t do, yet regularly lose money spreadbetting via IG or lending on a house fix-up with their mate who’s a builder & then something went very wrong on the project, so they actually lost money instead of earning interest.
Risk should really be taught at school for all aspects of life – people can put days of research into the most appropriate phone contract for their needs, but marry a stranger knowing zilch about their medical, financial or criminal records. An ugly truth about those snared in scams though is that a lot simply succumbed to naked greed …..but I do have a lot of sympathy for the genuinely unlucky though.
It feels like its getting harder to play dodge the bullet these days, just a couple of days ago my laptop screen froze & the ‘google security’ message warned me they’d warded off a serious attack, giving me a number to call for help. A quick search using that number via another gizmo quickly revealed its a currently popular scam, but on asking around, a couple of sheepish acquaintances admitted calling, before thankfully terminating on realising they were asked to effectively give the ‘helpcentre’ remote control of their device.
Bitcoin defintion: everything you don’t know about finance combined with everything you don’t know about computing.
@Survivor
The problem here is the human brain struggles to intuitively deal with statistics. Its just no good at it. Risk is inherently statistical. People get taught statistics at school but its in one ear out the other. Professional statisticians routinely get basic statistical questions wrong. It isn’t possible to get people to be good with risk. Those that are are outliers.
Crikey Mr. S – who’ve you been marrying to warrant such checks?
@ TR – re: Risk comprehension being complicated, I fully agree with what you say about the statistics lessons, I struggled through both school & varsity, several times, trying to get it….. But, surely there must be something qualitative that could be done, even just getting people to see that ‘it exists’ – then options to deal with whatever situation you have – using common, everyday examples.
Re: choice of partners/past disasters …..not saying, really don’t want to talk about it 🙂
If you struggle with understanding probability and risk read Gigerenzer. Excellent book.
https://www.amazon.co.uk/Reckoning-Risk-Learning-Live-Uncertainty/dp/0140297863/ref=pd_lpo_sbs_14_img_1?_encoding=UTF8&psc=1&refRID=2A1F0FWZHFMFP1FZGBYH
It doesn’t have to be that exotic an investment. Me, 1989, housing, a long, more than a decade crawl back to breakeven relative to renting… The devil was in the leverage of a mortgage
Every other blighter in the UK says housing=money tree because of that leverage…
@Survivor – So… an escaped bank robber with an STD?
@Marci – unwise, I would say 😉 Using a different platform for some of those wrappers wouldn’t do any harm, and Vanguard isn’t the only all world tracker provider. Yes, you’ll pay a little more TER/wrapper costs, but then insurance always costs a little…
@ hosimpson, close enough: an escaped house- [mine] robber with a PhD. [in sociopathy]
…..irresistible jokes aside, I meant like when you see articles on serious naivete [& know its realistic because anecdotally your own peers who aren’t stupid, do it] where people are blow away shocked that when you divorce, your ex can loot a joint account & you’re as liable for it/suddenly faced with unpleasant types well known in the security industry.
@Dearime – with you on Gerd Gigerenzer (What a name!)
“Reckoning with Risk” Very accessible and eye opener about risks across the board. although “Risk Savvy” and “Gut Feelings” may also be worth a delve. Want to know the chance that those pesticide soaked apples will kill you? (Hint: It’s less than winning the lottery). Or dying in a road traffic accident? (Hint: Its greater than winning the lottery!). Check with AbeBooks.co.uk for second hand versions cheaper than Amazon.
Some of his other books, such as an heuristics, are unfortunately less accessible, for all they are erudite.
PS Thanks for the post TI. Great die. What board games have you been playing?
It really brings back the quote from hustle “You can’t con an honest man”. The people who expect something from nothing end up paying something for nothing.
But it bring into question, where is the line? When is an investment an investment? Rather than a gamble? I’m sure we’ve all got our own opinions on whether a specific speculative investment would be considered good or bad.
@marci
Your question reminded me of a JLCollins post:
http://jlcollinsnh.com/2012/09/07/stocks-part-x-what-if-vanguard-gets-nuked/
My take on it is, even if the underlying holdings are ring fenced, if Vanguard was to go to the wall, how easy would it be to get hold of your money. Saying that, a lot of my ISA and pension is with Vanguard.
@Mat – I have read that post and I think the Oblivious Investor wrote something in a similar vein?
Pragmatically, I don’t buy it though, I think TI and Ermine are more right (less wrong) on the matter?
I definitely need to do something with respect to this..
I agree with other comments here that it is most likely (in a very unlikely scenario) to be an access issue, not a losing all your money forever issue.
However access might not mean a “slow web connection” type scenario, it could mean “long unwind that takes six months and perhaps we’re in some sort of meltdown scenario where inflation is running at 10% and frozen assets are depreciating or whatnot” scenario.
And then there’s the very very remote possibility of some kind of systemic/technical failure that has been going on for 10-20 years, that needs a government to bail out. (I’d say extremely unlikely and anything I put forward would sound like fantasy, but if we learned anything from the bank runs, failed investment banks, and negative interest rates of the past decade it’s surely that bad dreams can come true…)
So I’d personally always split my assets across a couple of platforms, on top of much other stuff. Others may feel differently, and I can certainly respect the argument. We’re talking very small probabilities here most likely.
Also worth saying that if you double (/triple / quadruple) the number of platforms you use, you’d also increase your chances of having *some* money in the platform that goes down, in the very unlikely scenario one of the big respectable ones does. (Mathematically if you had money on every platform in the world, you would definitely be exposed to the one that fails. Then work backwards and decide on your chances.)
From that angle I think saying “I have decided Vanguard is the biggest, safest, strongest, most prudent asset manager and so the least likely to go bust so I will have all my money with them” is a credible argument. (Not saying they are, though they’re probably not far off.)
But there’s still a tiny chance of something bad. And I am wired to think about such. 🙂
One of the reasons smart people make mistakes is the fallacy of transferability of competence (I am sure there is a proper technical term for this, but I can’t find it at the moment). I am a PhD scientist, surely I can do my own plumbing! How hard can it be? Turns out it is not that hard, but I have very little competence.
So busy people appraise a new situation using the heuristics that worked for them in the past. Sometimes it works, especially where it is a general heuristic applied to a general situation – a well-honed bullshit detector works in a surprising number of situations. Often it doesn’t work, with disastrous consequences.
A recent example, my son worked briefly in marketing for a Silicon Valley start-up. He was supposed to be reporting to a marketing director that they never got around to hiring. So the founder and CEO (an engineer) decided to do the job (I’m a skilled engineer, I developed the product this company is about, how hard can marketing be, they don’t even have proper degrees). The company was terminally unclear who their target market was and why that market should care. The CEO spent all his time debating grammar with son, and refusing to engage in discussions about what the hell their company story was. Net result, months of unhappiness followed by parting of the ways.
So it is entirely to be expected that people assume that they can transfer their decision-making processes from one domain to another. It’s human nature. And with that transfer comes assumptions that are probably incorrect.
Many of my friends are in the same position of people who never do the shopping when you ask them the price of a pint of milk. Their assumptions are all wrong. If you think that the ‘normal’ rate of interest on a savings account is 6%, and you can only get 1%, it is easy to start believing that the 1%’ers are just ripping you off, and anyone who offers 6% or higher is just doing their job properly. And FOMO can easily suck people into bitcoin, land or whatever the hot property is today.
We all have our blind spots. The challenge is to work out what they are, and to be very careful of System 1 thinking in novel situations.
If anyone knows what that fallacy is really called I would like to know. It is bugging me now!
@old_eyes — Not sure either, but this might help: https://upload.wikimedia.org/wikipedia/commons/a/a4/The_Cognitive_Bias_Codex_-_180%2B_biases%2C_designed_by_John_Manoogian_III_%28jm3%29.png
Overconfidence. Or the overconfidence effect if you want to get fancy.
I wonder if its easier to get caught out in an area where your expertise is low but suspicion is high or in an area where your expertise is high but you’re complacent. Sometimes I wonder if I’ll wake up in 10 years to discover passive investing was a massive swindle and me the unsuspecting patsy. How embarrassing!
@The Investor – A google search attributes your quote (cannot be created…. etc) to a 1999 paper by Clark and Varma entitled “Strategic Risk Management: The New Competitive Edge” I believe.
So unless you pre-date that…
@Kraggash — Hah! 🙂 It’s such a neat idea I’m sure someone has had it before, so I wouldn’t be surprised. That said I can’t look inside that paper to see the quote, so my personal jury is still out. 😉
Re: splitting up your investments – this seems like the tiniest of risks for people to worry over? As an investor, as I understand it, as long as you haven’t given access to an advisor/broker to manage your account (and I haven’t) you own the underlying assets, the broker does not have access. This level of protection extends past the broker to the mutual fund company whose fund you have purchased. As the investor, you own the stocks in the fund, and the mutual fund company can’t touch those underlying assets, is my understanding. I believe this is true in the US, at least.
For this reason, I don’t really see a lot of risk holding a single, simple lifecycle type fund with one of the larger fund companies. Many of us in the US have little choice regarding multiple brokers if we’re carrying most of our money in a 401k anyways. Virtually all our accounts are held at one broker, and while we currently hold a variety of funds within those accounts, I suspect that when I retire I may do something simple like one of the Vanguard single fund options. This may generate a very slight increase in risk of loss if the broker or mutual fund company goes under, but it is likely to greatly reduce the behavioral risks of managing a portfolio as we age, especially if I pass first, since I do all the investment management for the family.