Be wary of Wall Street’s latest attempts to convince you that you can have it all: high returns, principal safety, and immediate liquidity. Real investing involves trading one important feature for another. In other words, you can’t have everything you want.
We’re greedy, and we’re fearful. Everyone wishes for big returns on their investments but would rather not take any risk. Knowing what you want, many financial product pushers are willing to promise you anything to make the sale.
Our impossible dreams have lead to the creation of all manner of complex, convoluted, costly investment vehicles like index insurance products and alternative (hedge) funds. All of these cleverly contrived products have one thing in common: they are unlikely to be able to deliver on their promises over the long haul.
Ten years ago brokers promised investors higher than average returns with little or no risk through confusing derivative securities. Products like collateralized debt obligations (CDOs - which were supposed to be high-yielding and safe) or auction rate notes (which promised high yield, safety and liquidity) were all the rage. For a while, they delivered as promised until suddenly (2008) they didn’t, costing investors billions in losses.
Today’s low yields have created an environment in which investors are vulnerable to the temptation of promised higher yields from complex products like expensive liquid alternative funds or unconstrained bond funds. These “alternative” products are very expensive and almost impossible to understand. These features help Wall Street and hurt you.
Consider the costs: According to Morningstar the average annual expenses for alternative funds is 1.88% per year. One of the safest securities, one-year Treasury bills currently yield around 0.22%, and ten-year Treasury notes return about 1.80% per year.
These low, market-set rates illustrate the impossibility of these alternative funds investing in truly safe products. To overcome the drag of fees in the 2% per year range, they must play complex and typically dangerous games with your money to create a net return that even match that of treasury notes.
High returns with no or low risk are today’s version of turning lead into gold. Medieval alchemists failed in their attempts to create easy, risk-free wealth. Today’s financial “alchemists” will also be unsuccessful in their attempts to create wealth without risk. For them, defeat is the same as a victory because they get paid no matter how bad their products. As always, it’s the client that pays the price of failureIf
You can never forget: If it sounds too good to be true, it is!