Wednesday, February 18, 2009

Don’t Be Stupid When Chasing Higher Yields

One of my biggest financial pet peeves is when people refuse to realize the connection between return and risk. Whenever you see an investment that offers a “guaranteed safe” or “insured” return that is significantly above what an FDIC-insured bank can offer, it’s safe to assume that your risk has gone up.

The latest example is the Stanford Investment Group, which the SEC accuses of massive investment fraud:

SIB has sold approximately $8 billion of so-called “certificates of deposit” to investors by promising improbable and unsubstantiated high interest rates. These rates were supposedly earned through SIB’s unique investment strategy, which purportedly allowed the bank to achieve double-digit returns on its investments for the past 15 years.

Do the math, people! Double-digit returns + a bank based offshore in Antigua + no FDIC-insurance = Either fraud or risk to principal. And remember, in schemes like these the interest is always very reliable, coming every single month like clockwork…. until one day it doesn’t. Been that way since the real Ponzi.

And there are plenty more to replace SIG, just Google “high yield CD”. Back in 2005, there was American Business Financial Services, which imploded. Now there is Millennium Bank (based in St. Vincent), Zannett Notes, and CPS Notes. All offer well over 8% interest.

Now, I am not accusing any of these companies of fraud. There is a difference between fraud and plain old credit risk. In both bases, you might manage to cash out before things fall apart, but there’s also a real chance you might never see your money again.

But especially in times of low interest rates, people start to look for just a bit more yield. Even SmartMoney magazine has gotten caught up in the act. Check out their cover this month.

A sure 7%? What, from buying shares of stocks with temporarily jacked-up yields like Altria or Vodafone? How about a highly speculative 7%? Bank of America had a really nice dividend yield as well once upon a time… before it got cut to a penny. Add in the fact that your share price could drop as well, and I’d keep your emergency fund far away from these stocks. What a way to sell magazines, SmartMoney.

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