Did we not laugh at the gullible RBI official who fell prey to the Nigerian scam or the policeman who shared his bank details to a call centre agent? Also keep in mind, sophisticated investors in the most sophisticated market in the world still got scammed by Madoff.
What we are interested is how to avoid getting scammed ourselves. “You have got to ask yourself one question. Do I feel lucky?” - the same question that Client Eastwood asked in Dirty Harry.
As markets make new highs, one gets more emails and messages, which highlight the accomplishments of traders who have found a formula for making money. Options trading seminars and webinars are proliferating. Everyone seems to claim to know someone who has converted Rs. 10,000 to Rs. 10 Lacs by options trading. Or by investing in some micro-cap, which has gone by 1000 times. Constant coverage of rising markets by media gives a left out feeling to most people.
An old Wall Street adage highlights the frustration of an investor who sees friends getting rich. This happens in Dalal Street too. If the correction does not set in, the pink papers will write glowing tributes about various investors who have made zillions by smart investing. This will also add to the left out feeling.
When you get a mail in your inbox literally screaming that even you have the key to riches, that is when you must remember Dirty Harry – Do I feel lucky? Risk and return are joined at the hip.
Therefore, start with return – check what returns are you getting. If you cannot calculate or understand the returns side of the equation – delete the mail and move on. None in the entire world is so generous to help you convert Rs. 10,000 to Rs. 10 lakhs, for that matter even Rs. 1 lakh.
If you can calculate the return, then compare that return with risk-free return. I suggest use SBI’s fixed deposit (FD) rate, which can be easily googled and that is the closest you will get to risk-free return in India. If you are financially savvy, then you can check the Government of India bonds, but SBI FD is good enough. Check the difference between returns promised and SBI FD rate for the equivalent time period. For example, if someone if offering you 18%, and SBI FD rate is 8% (hypothetical number) over 3 years then you are getting 10% more. This 10% extra return is what you get for taking on higher risk.
In most cases, such risks are not justifiable. In life, return of capital is more important than return on capital. In such high return schemes, almost without fail, your principal itself may not come back.
Let me also tell you on what kind of equity returns you can expect on average, over long periods of time. If the economy is growing at 6%, inflation is 4%, then if you get 12-14%, you must feel happy.
The next time, you are offered a scheme that will make you rich overnight, ask yourself – Do I feel lucky? If answer is Yes, then apply the filter. Check the difference between returns being offered and SBI FD rate and get a handle on the risk. If you are happy taking on the risk, then go ahead. There are two possible outcomes – your investment pays off. In such a case, you can share your expertise in various forums. If it does not, then mark it down as learning. And don’t blame the universe, regulators, broker and experts but accept responsibility that your greed is to blame for this. Mark the loss to your learning account and move on.
What does not kill you makes you stronger, said Nietzsche. My take is - What does not bankrupt you makes you a better investor.
Stay safe in health and wealth.