Financial & Investment: February 2007 Archives

I got an email asking me about whether purchase money loans were risk free, as in the buyer could walk away without consequence. Well, it's not the case: There are consequences to credit, tax consequences, and consequences to future financial ability.



Now this was a real estate agent, but it could have been any other kind of financial advisor, or anybody at all. I've seen members of just about every financially related profession who were completely ignorant of one of the most fundamental facts of investment: There is no such thing as a risk free investment.



There are all kinds of risk: investment risk and currency risk on one side, inflation risk and reinvestment risk on the other. There is even solvency risk (the risk that the entity that owes you the money will be able to pay) and guarantee risk (the risk of the entity standing behind an investment that is guaranteed being unable to pay). Real Estate has liquidity risk, which most investments do not have to nearly the same degree. There are more sorts of risk than I can really go into here, but there is no such thing as a risk free investment. Each possible investment has varying levels of different kinds of risk, but there is always risk, even in government insured investments. Successful investing is managing the level of risks versus the rewards. You may be able to load the dice, but you always have to roll them, and no matter how well you load them, they will come up snake eyes sometimes. There are risks in government bonds, government insured bank accounts, insurance - everything, including keeping your money in a mattress. Whether or not you understand them, risks are present. There is no such thing as a place to keep your money that is free of risk - not even in your mattress (which has inflation risk, theft risk, and destruction risk)



Investment profit is a reward for overcoming risk. If it were automatic that you make money every time you make an investment, more people would do it more often. Of course, if that were the case, the rewards would also be much less. Supply and demand: If demand remains constant, and the supply increases, then the reward you have to offer them as an inducement becomes much less. The fact that there is a downside is one of the reasons the upside is as high as it is. If Aunt Edna could risk her pension money and be certain of getting it back with a profit, what reason is there not to do it? So she would. So would a lot of other people.



But there is the risk of effectively losing some or all of your principal. Fear of risk, particularly risks they do not understand or cannot control, keeps a lot of people on the sidelines, which means there is more reward for the rest of us and thank you very much. But on a regular basis, some clown tries to pretend that there is no risk so they can lure unsuspecting thralls of fear (many of whom have money) into making some investment they would not otherwise make.



Forgive me if I get angry for a minute: You have no business anywhere near a profession that has responsibility for other people's money if you don't understand that there is no such thing as a risk free investment. Furthermore, you have no business anywhere near a profession that has responsibility for other people's money if you are willing to say that there is such a thing as a risk free investment. Get out now before you go to prison. For that matter, have the courts appoint a legal guardian for you, because you are clearly not a responsible adult. Nor am I talking solely about financial advisers. Accountants, insurance agents, real estate agents, loan officers, lawyers, and any number of other occupations are part of this. Dishonest lazy selfish cheating alleged professionals use the "no risk" come on somewhere in the country every day, and every day it results in people losing large amounts of money or worse. If you cannot "sell" someone on the benefits of your chosen investment even with a frank discussion of the risks, then you should be barred from the industry for life. Life is risk. You win some, you lose some, and sometimes the Fickle Finger of Fate ends your game permanently for no good reason. But if someone wants to avoid a certain kind of risk, nobody should be talking them into on the basis that there is no risk. Explain how the risk works, yes. Address any irrational fears, yes. Explain precisely how you intend to "load the dice" in your favor. But claiming the risk doesn't exist because you get paid if they believe you is criminally irresponsible in every case. I can point to real estate agents and loan officers who have dates with a prosecutor coming up, and more who should have dates with a prosecutor scheduled, because they made this claim.



If anyone ever claims that "there is no risk" in some investment, walk away. Quickly. Actually, you should probably run. Because there's a con game going on, and you don't want to be one of the ones left without a chair when the music stops. Better not to get in in the first place, but get out immediately if you're already in. The ones who get greedy while thinking, "Just a little longer, just a little more" are the ones most likely to get burned.



Caveat Emptor