Avoid big losses

5 July 2015
Dr Larry Haverkamp


THE best investing advice may be the simplest: Avoid big losses. It's easy to get caught up in the excitement of a deal and then you dive into a bad one. And it is even worse if it's a scam since you not only lose your money, you feel stupid too.

Take an obvious scam like my new e-mail friend from Nigeria, Olami Onojowan, who just wrote to say he wants to give me $30 million if I will send him $500 to show my sincerity. No one would fall for that, right?

Apparently some do. A former scammer in Nigeria said he averaged seven replies for every 500 e-mails he sent out.

Your best and maybe only protection is the standard advice: "If it sounds too good to be true, it probably is". But that advice is easy for the scammers to short circuit. How? just scale back a bit and make the deal sound "almost too good to be true".

OLD SCAMS AND NEW
That was behind the evil genius of the biggest scam of the century (so far): The Madoff Fund. Bernie Madoff knew it would be a sure tip-off if he promised 50 per cent yearly returns. So he offered something less. He paid investors an average of 10.5 per cent per year for 17 years. Of course, it was a Pyramid scheme with the "return" to old investors coming from new investors' money.

Bernie made no guarantees, although the Madoff Fund's past returns showed a good track record with never a loss. Even in 2008, at the depths of the great recession, his fund posted gains of 5.6 per cent while the US market lost 38 per cent. (Bernie was finally caught in December 2008.)

The Madoff Fund returns were high but believable, and so the reliable rule "If it sounds too good to be true ..." failed.

Here's another one: Have you heard of crowdfunding? It is a new way to raise money using online sites like GoTo.com and Kickerstarter.com.

Need a million dollars to develop faster-than-light space travel? No problem. Post it on a crowdfunding site and try your luck. You can borrow money, or issue shares if you don't feel like repaying. The concept has caught on and it might even replace banks some-day (in the distant future). Crowdfunding always seemed to me that it had the potential for a Producers-type of scam.

Remember the movie The Producers? It's about two guys who wrote a play called Springtime for Hitler in Germany and they made it so distasteful that it couldn't possibly succeed.

These scammers sold 400 per cent ownership and sat back to wait for it to flop on opening night. To their amazement, the play was a hit and they couldn't repay even a fraction of the money, so they were sent to jail (where they immediately started scamming inmates).

It has finally happened with crowd-funding and in June this year, the US Federal Trade Commission charged Erik Chevalier with raising US$35,000 ($47,000) to fund a monopoly-like board game. It was over-subscribed and in just 30 days, Erik received US$122,000 from 1,200 eager Kickstarter.com investors.

He immediately declared that his venture had failed and apologised to investors, saying: "Every possible mistake was made, some due to my inexperience in board game publishing ...". But he kept the money anyway, which triggered the US government's charges.

The case is pending but Kickstarter said that it "cannot guarantee creators' work". It also doesn't offer refunds and proudly said: "Kickstarter creators have an incredible track record when it comes to following through on their promises..." Maybe. But this one didn't work out.

LEGAL SCAMS
Can you call it a scam if it's legal? You be the judge.

In my opinion, gambling is the worst legal scam. People seem to think a little fling is harmless as long as it doesn't take food out of the mouths of their kids. But why do it? Why throw that money away? No one has ever won in the long run from playing games of chance.

Worse still, who understands the odds? Does anyone playing 4-D, Toto, horse racing or sports bets understand the "house advantage", which is the per cent that Singapore Pools, the race track or the casino takes from the average bet?

It is usually small but the profit comes from volume and if you play long enough, you are sure to lose your initial stake. To add to the confusion, the odds are different for each game, so it is hard to know which game offers the best odds (but "best odds" only means you will lose your money more slowly).

One more sure-lose but perfectly legal investment is jewellery. As a rule of thumb, the value of jewellery falls by 50 per cent the moment you walk out of the shop. It is a nice way of saying that a $100 gold bracelet has only $50 worth of gold. You pay mostly for "workmanship".

My wife read up on all the problems,with investing in jewellery and asked me not to buy her any more for special holidays like birthdays and anniversaries. Being a good husband, I follow those instructions.

By the way, a great place to check for major local scams is the National Crime Prevention Council's web site at: www.scamalert.sg.

Ihaverkamp@smu.edu.sg

An adjunct professor at SMU, Dr Haverkamp contributes this column weekly to help our readers understand money matters better.