Let's talk money.

One of our main functions as advisors is to not only give recommendations, but also to provide reasonable expectations of return and risk that our client’s portfolios have and have that discussion with our clients. This function, at times, may have high importance to ‘smooth out’ our clients’ behavior and emotions especially at times of heightened market volatility. At most other times it serves as a reminder of what is ‘reasonable’ in the world of investing and what borders unreasonable or fraud. We cannot know for sure what returns we will have in the future, but knowing historical trend lines we can have an understanding of a range or the expected long-term average.

This ‘management of expectations’ is one of the most important exercises that all advisors should do and many already do with their clients. But still, a large number of people that don’t have the knowledge of ‘expected investment returns’ very often fall for different ‘too good to be true’ investment schemes and most of the time they part with their money. A recent Bloomberg article quoting a FINRA survey shows that many people ‘want to fall’ for these definitely appealing, but actually fraudulent investment schemes that offer ‘unreasonable returns’. Even on the non-fraudulent area of investment returns, people tend to follow (and invest more) on the guy that performed 60% or 70% or maybe even 100% return last year. The point is that those returns have to be seen with a skeptical eye, that even if not fraud, it could have been a one-time event, pure luck, or just extreme risk taking (working out well). And how do we know this???

We know very well that over the long run, a diversified portfolio with equities alone (assuming no bonds) has returned no more than 10%/year on average over the very long term (200 years or so). Yes, the range has been wide, and there have been high negative returns as well as high positive returns, but overall the average has been maintained… that’s why continuing returns of 50%, 60% or more per year will be unrealistic for the foreseeable next few years. The best action from the very beginning is to set realistic return expectations with your advisor and stop yourself before you jump on the ‘this is too good to miss’ bandwagon.

Some facts below from the FINRA (financial industry regulatory authority) survey on why people, even in the developed USA, still fall for the ‘too good to be true’ investment schemes.

Bloomberg Article
…..“Here are a pretty amazing press releaseand report from the Investor Education Foundation of the Financial Industry Regulatory Authority; the themes are basically (1) you can't fool an honest man but (2) that's okay because you can't find one either. People are dumb! And greedy! From the report, which surveyed 2,364 Americans age 40 and older:
- Many Americans lack an understanding of reasonable returns on investments, leaving them vulnerable to fraudulent investment pitches promising unrealistic returns or guarantees of returns.
- Nearly half of respondents found a daily rate of return of over 2% appealing.
- Claims of achieving “typical” returns of 110% per year were found appealing by 42% of respondents.
- A majority found a statement in an investment pitch that guaranteed the safety of the principal of an investment to be appealing.

It also found that people are getting these pitches constantly. The market for financial fraud is very efficient, and supply has arisen in response to demand:
- 67% said they had received an email from another country offering a large amount of money in exchange for an initial deposit or fee.
- 64% had been invited to an “educational” investment meeting that turned out to be a sales pitch.
- 36% had received a letter stating they had won a lottery in another country, including a cashier’s check as an advance payment.
- 30% had received recommendations to purchase a penny stock.
- 24% had been cold-called by a stranger offering an investment opportunity.
- 18% had been asked to participate in an investment that offered a commission for referring other investors.
- And "At least 16% of all respondents invested money in response to at least one of the likely fraudulent offers," though only 4 percent said yes when "asked directly whether they had ever participated in a fraudulent investment."

Even after being defrauded people seem to be in denial about it. Which is great news if you defrauded them: if they're too embarrassed to report fraud in an anonymous survey, they're probably not going to the police. Obviously it's less great news if you want to prevent fraud. FINRA and the SEC actually do great work in putting out investor alerts saying things like, "No one should ever make an investment based on the advice of an unsolicited email," but of course the number of people who (1) might do that and (2) spend a lot of time reading the FINRA or SEC websites, is basically zero.”


Patrick Volk
Lead Advisor, InvestEd.

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