High returns mean high risk: It’s that simple

Interesting article in the Vancouver Sun this week by Vancouver-based portfolio manager, Michael Schaab, of Leith Wheeler Investment Counsel.

Schaab tells investors they need to take a closer look at the risks of chasing yield. “Making investment decisions based on yield alone can frequently end in disappointment. Higher yields do not indicate better investments. In fact, they sometimes point to more dangerous ones.”

BCSC InvestRight research published earlier this month delves into that danger zone. We surveyed almost 2,500 Canadians 50+ to find out what makes people vulnerable to investment fraud. It turns out that our relationship with investment yield is at the heart of it.

Yield is simply the income return on an investment, usually expressed as a percentage, and also known as market return.

When we asked Canadians 50+ how they would respond to an obviously fraudulent investment offer—a guaranteed 14% – 25% return, risk free—1-in-5 said they’d look into it. For them, the lure of high yield was more powerful than the common sense understanding of risk and return: the higher the return, the higher the risk.

We also asked Canadians what a realistic rate of return would be in today’s market. Fully 75% either didn’t know or expected higher—and sometimes much higher—returns than are now available. By our calculation, a reasonable yield these days is under 4%.

Having unrealistic expectations of market returns and not understanding the relationship between risk and reward can make people vulnerable to investment fraud. Especially, as our research shows, for those worried about low rates of return or afraid they will run out of money during retirement.

Being fraud aware means having the knowledge and perspective to spot scams and avoid them. Avoiding scams involves resisting the lure of too-good-to-be-true investments that might be an unproven business that could fail, or an out-right fraud. Sometimes the best investment we can make is to walk away.

If you’d like a little fun seeing where you stand on the fraud vulnerability front, take the InvestRight Investment Fraud Challenge. The lower your score, the less vulnerable you may be. And you might even win an iPAD2.

The BCSC InvestRight Fraud Vulnerability survey was conducted among 2,461 Canadians by Innovative Research Group in January 2012. The results have an estimated margin of error of +/- 2.0%, 19 times out of 20.