Friday, November 06, 2009

Personal Finance Part 14 - Scams, Trickery and Dodgy Behaviour

Recent news on the trial of the founders of the dodgy Sunshine Empire had highlighted to me the dangers of falling prey to scams and trickery, and also left me surprised as to how many people got caught in this web of deceit; with some experiencing an almost total wipe-out of their retirement savings. It is a sad fact but a reality that a lot of people out there are simply out to con your money, and hardly are interested in helping you to grow it (in fact, they are more concerned with growing their own pot of gold). This mantra also applies to salespeople, brokers, remisiers and all those who seek to earn commissions through selling you financial advice. The term “caveat emptor” or “buyer beware” has never rung more true, and recent cases such as the Madoff and Satyam scandal only serve to highlight this problem which retail investors face. In the case of Sunshine Empire, it is my opinion that it was obvious that it was a scam, though the people who got swindled obviously could not see it as such.

One classic characteristic of scams is their ability to prey on one’s greed and desire for quick wealth. The Sunshine Empire office was beautifully decorated with expensive furnishings and the staff there were impeccably dressed and very polished in speaking (but obviously, not in delivering). The staff are trained to feed gullible investors with grandiose claims of spectacular returns and impressive-sounding projects (e.g. underwater hotel in Malaysia), in the name of conjuring up images of being vested in something lucrative and successful. Many of the victims had admitted that they were seduced by the Dark Side and gave in to greed, neglecting to do their due diligence and to check if the claims were for real. It is strange that educated people can fall prey to scams which offer a return of more than 300% per annum consistently, but I have realized that when it comes to greed and the lure of quick money, almost anyone is inclined to believe anything!

Any reasonable person on the street would be able to vouch that a return of such a high magnitude would be impossible to sustain for an extended period of time. This is because in the sale of goods and services, all businesses have to follow the basic laws of economics, which dictate demand and supply. Even if there was sustained demand for a company’s products, they have to ensure that this cannot be easily replicated by competitors and their profit margin eroded through competitive pricing. Consequently, most companies can grow at most 20-30% on average over the long-term, though in initial phases grow can be as dramatic as 100-150% per annum. Sunshine Empire did not provide a detailed prospectus or Fund Sheet or even financial statements and status updates on the projects they were (supposedly) doing. This is as good as investing your money in a hedge fund where the activities are enclosed in a black box and all you see are the reported returns. To me, this is never a comfortable way to invest when all available information is not readily supplied.

It would also have been obvious that it was a scam due to the fact that no real products were being sold, but instead rebates were given for introducing new members, giving the instant impression of being an unsustainable pyramid scheme. This is the case where new entrants pay for the profits of the older participants, who are lucky enough to exit at the top of the pyramid with supernormal returns. But the vast majority of those involved in pyramid scheme (also known as a Ponzi scheme named after the notorious Charles Ponzi) lose all or a substantial portion of their “investment”.

Ultimately, the question of human psychology comes into play. Why do human beings choose to abandon rationality and sanity when they encounter such get-rich-quick schemes, and throw all caution to the wind? I believe it boils down to the desire (in Singapore at least) to keep up with the Joneses, to get something for almost nothing, and for instant gratification. It was mentioned that a lot of undergraduates in their early 20’s and late teens fell victim to Sunshine Empire’s scam, and sad to say I believe this is the generation which has grown up to believe that money is easy to come by, and who have also been influenced by ideas of instant gratification, conspicuous consumption and “living it up”. All these may contribute to a false sense of security and a feeling of invulnerability and may make these youngsters too bold and careless when it comes to investing their money (and their parent’s money as well). Perhaps I am being too judgemental, but I feel that financial literacy and basic financial education should prevent these people from being conned. An ability to control emotions is also essential to prevent yourself from being “swayed” and influenced by these smooth, suave conmen.

So the phrase buyer beware really applies in such a situation. It is your responsibility to be careful and aware of where your money is going, and though a lot of Singaporeans claim that the Government has a fiduciary duty to protect the vulnerable retail investor, there is certainly no protection for ignorance and greed. Whether it be Sunshine Empire’s Ponzi Scheme, dubious land banking claims (from Profitable Plots) or questionable business models (e.g. Oilpods); what these have in common is that they promise a lot, but deliver precious little. It is always much better to promise a reasonable return but deliver in excess to that, than to promise spectacular returns only to burst the proverbial bubble of exuberance.

18 comments:

Jeremy Ow Tai Pang said...

Hi MW,
I totally agree with your opinion to why people still got con by such investment scams. It is the basic greed that got people into such mess also similar to the structured products episode. Real risk comes from not understanding what one is investing in. Ask some average joe in the street why they buy certain investment products. Typical answer will be, "My financial adviser said it was good." or "Many banks are selling this investment product, so it cannot be that bad afterall right?" Or even in buying stocks some people hear from others which stocks promise fast returns, they will then rush in to buy the same stock.

Risk comes not from how large the potential of making a loss on an investment, rather risk comes from not understanding carefully how the investment product one is buying operates. It is only after very careful and complete understanding of an investment product and forming an independent opinion apart from what the investment product peddler is hard selling, and the willingness to still invest in a product based on own careful independent assessment of the potential merits and short-falls, and willingness to absorb the worst case scenario (which is ability to take back at all or at least most part of original invested capital upon failure of investment) that risk is minimised.

Warren Buffett also mentioned before when addressing the stock market that real risk comes not from stock price movements unfavourable to the investor, rather real risk comes from not understanding the underlying business of a stock that one blindly buys into a particular stock.

la papillion said...

Hello,

I think some of the risk comes from overestimating your own abilities. Like trying to zig when others are zagging, or trying too hard to form a contrarian opinion opposite that of populur view.

Not easy...

PanzerGrenadier said...

Hi Musicwhiz

Greed and Fear is also pervasive even on established markets such as Stock exchanges.

Even on CNA's Market Talk forum, the amount of noise from the chants, doomsday scenarios coupled with buy calls tell us just one thing.

That human beings are fallible and we fall over each other over greed and fear.

But even established financial institutions can sell crap like CDO and derivative products calling them "low" risk investment.

Thus, the only real defence is skepticism, knowing that is no FREE or CHEAP lunch and that most net worth growth still comes from living within one's means to have savings.

Be well and prosper.

Spencer Li said...

Hey dude, I totally agree with you. It was funny when all of a sudden you hear students/NSmen with zero business knowledge start throwing around words like "business plan" and "ROI" with promises of insanely high returns.

When I went for their talks, they use brain-washing verbiage to shift the focus from their real business structure to the dreams of immediate financial freedom. This is totally manipulative to the unseasoned.

Personally, there are some good books on investing psychology, like "Beyond Greed and Fear" and "Investment Psychology Explained". The former focuses more on the new field of behavioural finance, but both shed interesting insights on how people think differently (irrationally) when it comes to money.

Cheers
Spencer
www.synapsetrading.blogspot.com

Akatsuki said...

Wow, i was about to write about MLM people also. Ive been to one before also, no proper prospectus, no annual report no nothing. They usually have this main guy who acts like a God telling you to have confidence in him..lol. I was like, erm no thanks.

Btw Musicwhiz do you have an email, so can email you something?

Musicwhiz said...

Well Jeremy,

I think the reason people turn to financial advisors is the mistaken belief that these people know a lot more about investing, markets and real rates of return. And planners/advisors themselves get ideas from other such people, so the whole thing is recycled somewhat. It's just like the case where funds have to buy mostly the large-caps, blue chips or highly liquid stocks even though they may be fully valued (or worse, overvalued!). Sometimes, one's hands are tied in this respect but the general public is unaware of this.

Risk is of course contextual and personal; and I agree it does not involve volatility but rather an understanding of what one purchases. However, there is implicit trust in professionals which states that they are paid and able to manage our money better than we can manage it ourselves (it's the general consensus). So unless one knows how to allocate capital very efficiently, one may just feel pressured to look for such methods of growing one's money.

That said, looking for short cuts to get rich is NEVER a good approach. Because getting rich isn't an instantaneous thing, it's slow and gradual.

Thanks,
Musicwhiz

Musicwhiz said...

Hi LP,

Yes that aspect of "risk" stems from behavioural finance - that of over-confidence and over-estimating your stock-picking abilities.

That said, if one's aim is for a decent +ve return on capital, I think one should not do too badly. But to expect something unachievable or impractical is just going to kill off the enthusiasm.

Cheers,
Musicwhiz

Musicwhiz said...

Hi Panzer,

Well forums which are unregulated tend to have 99% idle chatter and 1% serious talk. Even then, "advice" which comes FOC usually isn't worth too much, in my opinion.

One must always be alert to possible scams and tactics to cheat one of one's hard earned money. I guess when we become adults, we realize it's a dog eat dog world and some people realize it much later than others (i.e. only when they get cheated).

So I agree with you, skepticism is a good thing especially if it's too good to be true. Knowledge and education also come in very handy in this respect.

Regards,
Musicwhiz

Musicwhiz said...

Hi Spencer Li,

Yes, you are right about what you witnessed, as I had witnessed that too. These youths who think they know more than they actually do are trying to sell something which they do not fully comprehend. That's criminal, in my opinion. It's akin to selling a deadly drug to someone without knowing the true effects of it.

Sometimes I think the only way to avoid wasting one's time is to not attend such talks in the first place, unless you are doing it for some perverse pleasure or for research sake.

Thanks for the book recommendations. I like this topic on behavioural finance, and will check them out.

Musicwhiz

Musicwhiz said...

Hi Akatsuki,

Yes sorry for the late reply. I was kind of busy the entire week.

You can reach me at musicwhiz55@gmail.com. Thanks.

Cheers,
Musicwhiz

Ricky said...

Aren't there also the normal schemes which promises reasonable returns and just erode away your money too?

patrickho said...

Hi MW,

Popped by, and it was nice to see you still posting nice entries on personal finance. Keep it going!


Patrick Ho

TheKen said...

there will always be guillible people, especially because MLM uses this 'financially naive people' to sell the mlm's scammy products within their family and friends

only way is for the law to do heavy punishement/full justice on those caught...

if they earn $1mil and the law only fines 800k, then other 'potential scammers' will have the incentive to start a new scam

Musicwhiz said...

Hi Ricky,

Well yeah, but at least they are honest and are not out to cheat you. Certain events cannot be reasonably predicted and these legitimate funds are a victim as much as the client who purchased them. In other words, they could not help it.

Cheers,
Musicwhiz

Musicwhiz said...

Hi Patrick Ho,

Thanks for dropping by for a visit as well.

Regards,
Musicwhiz

Musicwhiz said...

Hi TheKen,

I agree. Harsh punishments should be handed down. I personally hate cheaters and swindlers because I believe in making an honest living (through work and investing). These people live it up by cheating other's monies. How despicable!

Cheers,
Musicwhiz

ZhuKoLiang said...

in my blog,

i explain all the trickeries used by MLM people http://invest111.blogspot.com

Musicwhiz said...

Hi Zhu Ko Liang,

Thanks for the link. Your blog is interesting!

Regards,
Musicwhiz