Guaranteed crazy returns? The joke's on you. Ronaldo Schemidt/AFP via Getty Images)
AFP via Getty ImagesWhy do people fall for these things? Why do investors, many of them elderly or retired, part with their hard-earned money in the dream of earning returns that are at the outer realms of absurdity?
The U.S. Justice Department and the Securities and Exchange Commission recently took action against a man calling himself “Dr. Cash” who had attracted $5 million from investors over several years with promises he would generate “quarterly cash dividends between 12% — 77% per year,” and “no less than 12% per year.”
The Justice Department has arrested the man, whose real name is Terrence Chalk, and charged him with fraud. The SEC is pursuing civil action against him.
Some of the investors “were retirees, including former civil servants, who were looking for a way to augment their life savings,” says the SEC. Dr. Cash persuaded many of his investors to liquidate their IRAs to invest in his plan, the Commission says.
Terrence Chalk could not immediately be reached for comment.
What has happened to the money, and the true nature of Chalk’s business, Greenlight Advantage Group, are going to be subject to the courts. So far, these are only allegations and defendants are presumed innocent until proven otherwise.
But you don’t need an MBA or a Ph.D. in economics to understand what’s wrong with someone promising you guaranteed returns of “no less than 12% a year” at a time when interest rates are 1% to 2%.
It makes no sense.
Nobody knows how to make a guaranteed return of 12% a year in this environment. If they did, they’d be making it themselves. Why would they cut you in?
As for 77%: There is really no point even discussing it. Hopeless.
The math of investing is really very simple indeed. Take the inflation rate, currently 1.4% a year. Add 6% (If you really care, you can go into it in great detail here, but 6% is a reasonable rule of thumb.) That’s the most you can reasonably expect from the stock market on average.
So, right now, the maximum “No B.S. Investment Target” is 7.4%.
Someone offering you more than that is either offering you a high-risk gamble, or lying to you and trying to steal your money. And the higher the number, the higher the risk—or the higher the likelihood that they are trying to steal your money.
The actual “guaranteed,” or “risk-free,” investment rate right now is 0.33% a year for five years. That’s what you can get from Uncle Sam, the only person in this country with his own (legal) printing press and no default risk.
If someone offers you a “guaranteed” return of 12% a year, ask them why they don’t just take it themselves. If I had a gold mine in my back garden I wouldn’t be standing there handing out picks and shovels.
Dr. Cash allegedly met his investors by offering them his services as a financial “coach” and adviser, for fees ranging from $4,000 to $20,000 a year. For this, says the SEC, you got his advice…over the phone.
During the conversation he’d get your financial information, including details about your savings and retirement accounts. At which point he’d pitch investments in his “Chairman’s Fund,” apparently an “elite Fund of Funds that include passive, lucrative, tax-exempt, strategic and diverse assets.”
Count the buzzwords.
So why do people buy into schemes offering them castles in the sky?
Mitchell Zuckoff, a biographer of Charles Ponzi, says the appeal is psychological as much as it is financial. “These schemes tend to tap into several powerful psychological forces, among them not only the dream of easy riches but also the fear of missing out,” he told me.
Ville Rantala, a finance professor at the University of Miami and an expert in financial psychology, told me different people jump in for different reasons. Some investors are elderly, isolated and possibly in cognitive decline, he says. So they’re vulnerable. Others are young, or middle-aged, and overconfident. Some are looking for a gamble.
One thing he said that really struck me was that dubious, high-risk and fraudulent financial schemes also benefit from the collapse in trust in our institutions. Many people would rather gamble their money with a smooth-talking salesman, especially someone from their so-called “community,” than trust the traditional financial industry.
It’s easy to say that not investing in an unregulated private scheme guaranteeing fantastical returns is simple common sense. But common sense, as someone once said, may be the least common of the senses, and many people are vulnerable. But the best regulation is an educated consumer, and we could help the next generation of investors by passing on more simple financial wisdom while they are in school.
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