No risk without reward

July 14th, 2013 at 9:00 am by David Farrar

Phil Kitchin at Stuff reports:

A Wellington couple lost $1.3 million after their financial adviser exhorted them to pour money into a start-up business he claimed couldn’t fail – but did.

Any claim a business can’t fail should be laughed at, especially a start up.

The couple, who were close to retirement, were persuaded to invest the money to recoup another $1.5 million they had already lost in failed finance companies.

So they wanted a 100% return on investment, and thought it was guaranteed? Do they believe in the Easter Bunny also?

I’ve made a huge return on buying into Xero at the IPO. But I knew it was a start-up and might fail. Hence I only invested the amount of money I could afford to lose.

McPhail also recommended recouping their losses by investing more heavily in a start-up, Zeroshift – an opportunity he said was unlikely to be replicated “in our lifetime”. His “worst estimate” was that they would at least triple their money.

If McPhail did say that, then they could have a case. Was this in writing?

McPhail told the Sunday Star-Times he had “every sympathy” for his former clients and regretted the losses they suffered – but rejected an attempt to blame him for the losses.

The couple knew Zeroshift was a start-up company which offered big investor profits if successful, but success was not guaranteed.

He said he had cautioned against buying more shares at one stage because of Zeroshift’s lack of liquidity and uncertainty about when it would be publicly listed.

This is a he said, she said type case. But regardless of what McPhail may have said, it is unwise to invest a huge proportion of your wealth in just one company – especially a start-up. The higher the possible return, the higher the risk.

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13 Responses to “No risk without reward”

  1. Stuart (38 comments) says:

    How do people like that get so much money to invest in the first place?

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  2. Longknives (4,039 comments) says:

    Yesterday my mates horse was running at Trentham- It was paying $17 to 1.
    My mate absolutely swore that it would win- “been working the house down” “won’t get beat” “jumping out of his skin” etc etc
    So I put twenty each way.
    The ‘unbeatable’ horse finished down the track. I blew my money…

    Shall I now go crying to the Media?

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  3. George Patton (330 comments) says:

    While the advisor should be hauled over the hot coals for such appalling advice (putting retired people into an unlisted startup is mercenary), and then sending good money after bad is appalling judgment, the couple in question were clearly morons of the highest order. That they kept the same financial advisor after losing $1.5m in finance companies suggests these people were gullible enough to hand out their EFTPOS PIN number on pieces of paper on the corner of Lambton Quay and Molesworth.

    If people don’t understand investing, then they should find a credible mutual fund, or buy into some index trackers like the exchange traded funds the NZX offer. They won’t outperform the market (who cares, why is this important when they are close to retirement), but they’ll make some money over time.

    Oh, and in case anyone is wondering, good investments have to be found, often by reading a prospectus. It’s the bad ones that get proffered to you with enthusiasm by half pint advisors.

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  4. peterwn (2,932 comments) says:

    Stuart – Retired farmers and small business people quite often have a few million that is looking for a home, but a few can turn out to be useless at making investment decisions. A small business person learns to be frugal with money, but finds it hard to kick the habit when there is less necessity to be frugal. A person who inherits money could be particularly useless at making investment decisions. At say 60 – 70 year old, they should consider a portion as a retirement fund and invest it as such. The balance they can have a play with, but no more than 10% in each high risk investment.

    This is how the ‘rich get richer’ to the bane of socialists, child poverty advocates, etc. They invest ‘spare’ money in risky ventures and if they apply a bit of common sense and think for themselves they will most probably come out on top. They have more money to invest, so will grow richer. Those who believe in ‘sharing’ and ‘social justice’ want to do a ‘Robin Hood’ with this money. However it is that money which fuels the economy, creates, jobs, etc – the Golden Goose.

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  5. burt (7,083 comments) says:

    So… like the Christchurch residents who either didn’t have insurance or who had chosen an insurance company based on the cheapest premiums… surely… the government must bail these people out. They have taken a risk and lost everything and that’s not fair… Perhaps the government could offer to refund their capital and these people could get all twisted out of shape that the potential needs to be refunded rather than the book value ?

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  6. burt (7,083 comments) says:

    Longknives

    Shall I now go crying to the Media?

    The government… don’t go looking for your $20 though – the government should be paying you $340 because that’s what YOU think that bet was worth.

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  7. Reid (15,500 comments) says:

    At say 60 – 70 year old, they should consider a portion as a retirement fund and invest it as such. The balance they can have a play with, but no more than 10% in each high risk investment.

    It’s a simple message and everyone knows it including, I imagine, these people. However, it’s a logical message and it competes with an emotive one in certain circumstances and when that happens, emotion normally wins out. The emotion being avarice. Dollar signs in their eyes would have all they were thinking about for days, possibly weeks before they signed on the dotted line. Everytime they thought about how they would spend their “win” they psychologically reinforced avarice until logic was a little troll sitting high up in the corner of their minds while their whole thinking time was pre-occupied with the emotional aspect of how, for example, they would buy their grandchildren this and that and how they would go overseas and where they would go etc etc etc. And everytime you build this picture, emotion comes in and reinforces it. This is how humans work.

    It doesn’t affect those with wealth or those who work in financial industries because both those groups have spent so much time learning about the rules that their logic is so well-developed and pervasive in their minds that avaristic tendencies normally don’t get a look in. Sometimes they do but normally they don’t. But for those of us who don’t do this for a living, but rather come to the decision only once or twice in our lifetimes, don’t have any of that. We don’t have thousands and thousands of hours thinking about the investment rules, and so we’re highly susceptible to the emotion. This is why frauds work all the time, even the ones which are so obvious once it all comes crashing down. The fraudsters are experts at evoking and stoking the avaristic tendencies lurking therein and it’s not just imagining you’re Scrooge swimming in the money bin, it’s about what you can do for your family, the house you will buy for your child, etc etc. That’s the hook.

    That’s the problem, but the solution is not obvious. Humans will do much more to avoid pain than seek pleasure, and part of the solution I think therefore lies in giving we investment amateurs access to horror stories like this one, so we can learn the lessons before it’s too late. But of course, no-one wants to publicly admit they’ve been complete plonkers, embarrassment is something people will do almost anything to avoid. But how about setting up a network, like the Sensible Sentencing, but of people who’ve been burnt, who are willing to share their experiences with someone local like say, the farmer whose just sold. There have to be thousands of people all around the country who have learned the lesson through fire, like these people and if anything good is to come out of it, I have a feeling they would be willing to help prevent others falling into the same trap. and all you’d need is a list of contact details on a website.

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  8. holysheet (191 comments) says:

    “A fool and his money are easily parted”
    Never a truer word was spoken.
    Another one is ” learn to learn from your mistakes”
    Both of these would have been good advice for the plonkers with more money than sense mentioned above.
    “If it sounds too good to be true, then it most probably is”
    One can go on and on. but the point is that these old saying are there because they have been proven over the years to be true.

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  9. Manolo (12,608 comments) says:

    As P.T. Barnum said: “One sucker (in this case two) is born every minute”.

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  10. bc (1,251 comments) says:

    I was wondering the same thing, Stuart!

    holysheet – another great old saying that still holds true is “never put all your eggs in one basket”

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  11. Warren Murray (237 comments) says:

    Shouldn’t the heading be no reward without risk?

    100%+ return on investment seems very optimistic.

    While i concur with others comments, i wonder:
    Did the ‘advisor’ explain the risk? The report suggests the returns were huge with minimal risk (couldn’t fail).
    Did the ‘advisor’ explain his interest / involvement in the venture?

    Sounds very dodgy and I suspect from reading the story that the advisor had a conflict of interest.

    It seems incredible that having lost so much money in finance companies, they didnt learn much.

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  12. Grendel (873 comments) says:

    oh dear,

    without knowing the full story (and we never will), its hard to comment in full knowledge and i am always weary when the media report a sob story (the first sentence using the word exhorted is a bit close to trying to link it to extorted for my liking).

    however, as an Authorised Financial Adviser i have a little knowledge on the generalities of this so here is my 2c.

    first thing to note is that Mcphail is a registered financial adviser according to the FSPR meaning that since 2011 he has not be allowed to give investment advice. the fact that he used to and now does not might mean that he has realised he does not have the skill and competence to advise on investing (and if the article is correct, that certainly seems like it), or it could simply mean that after the debacle with these (and presumably other) clients, he cannot be bothered with investment advice anymore.

    Now there are some basic tenets of investment advice that are law since 1 July 2011, but before that were at the least best practice which he (if the article is correct) did not follow. Some of the key ones are:

    Risk appetite – you have to get a picture of your clients risk appetite and capability. While they might want the high returns of a startup do they have the capacity to recover from a loss in capital?

    it would appear on the face of it, that he got this wrong.

    End goal – what were they investing for? income or capital? if they were at retirement age, then income would be the most likely so the need for massive returns (and commensurate risk) would be lower. however if they had very high income requirements, maybe they did need a higher return than a conservative fund. but i dont see why they would need a 100% return.

    I find it difficult to think you could not build a reasonable retirement income on 1.3M (yes 2.8 would be better, but that money was gone), plus NZ Super. if they had debts to cover he should have advised to clear them.

    Diversification – there was none, so huge risk – like the finance companies they already lost in, but worse.

    Conflict of interest – you are supposed to disclose your links to any products you recommend, and he may not have. Shady.

    Now what we dont know is what the discussions really were. its plausible that the couple demanded massive returns and he said this is the only way to get there, and here is the risk, what do you want to do? and they took the big punt. but i have my doubts. if thats the case, his file notes and sign offs will have it clearly laid out.

    My gut is that this is a failure of greed on both parts, on the adviser due to the income he presumably made from pushing the big investment (hopefully disclosed), and from the clients, who accepted the push for riskier returns. Now its mostly the advisers fault (if the report is correct) as he should have had the bigger picture knowledge but you would think that after losing the finance company money the clients had some serious questions to ask.

    Now this can be tricky as an adviser, i am dealing with some clients who are at retirement age and are conservative in both appetite and capacity, but they are looking at the past returns of some of the more growth (so volatile) funds and wanting to stick with them, despite the risks. you can be damned if you do and dont as an adviser.

    hopefully this article does not put people off getting advice, but encourages them to use appropriately qualified advisers and to pay attention to the discussion on risk vs return.

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  13. Left Right and Centre (2,388 comments) says:

    Smart enough to build up a big cashpile- and dumb enough to lose it all foolishly. Wow.

    Oh well, what do you do? Play the media card!! Not that that’s going to do a lot. But it might save someone else from the same fate…. something….

    The only thing I can think of is that over a certain figure potential investors *are forced to* read something for their own protection before parting with their money. I know, I know… nanny state. I’m just trying to help the poor beggars. It doesn’t have to be a novel… just something shortish with a few salient points about investing, risk, obligations, common investment strategies, likely outcomes. Basic advice at least in other words maybe?

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