Last week the failure of another financial institution hit the headlines when it became apparent that an estimated 14,000 investors in London Capital & Finance were unlikely to see very much of their money back. Total losses are expected to be well over £200,000,000.
Andy Jervis, Company Director, explains further and gives us ten guidelines for identifying when a deal might be too good to be true.
The firm was offering mini-bonds, a type of loan security that can help small companies to raise money from investors. Dealing in mini-bonds is a legitimate activity and doing so doesn't require authorisation by the Financial Conduct Authority, the UK's primary regulator for retail investors. That's because these bonds are normally the province of business and professional investors who understand what they are, how they work and the risks they carry.
Promoting mini-bonds to the public is a regulated activity though and does require authorisation. The FCA's rules make it clear that non-professional investors should be given a proper explanation of those risks so that they know what they're getting themselves in to.
London Capital & Finance didn't have that authorisation. That didn't stop them from offering mini-bonds to the public, though, saying in their advertisements that they were authorised – but failing to mention that their authorisation didn’t cover this activity. With attractive rates of interest of up to 8% a year being advertised for a three-year bond it's no wonder that lots of people were drawn in.
Stories surfaced of people who have lost their life savings in this failure. Distressingly, because London Capital & Finance were not properly authorised they also fall outside of the Financial Services Compensation Scheme, so it’s likely that the investors will have no fallback even though they appear to have been duped out of their cash.
We’ve seen all this before, of course, and I’ve no doubt we will see it again. It’s easy to say that these investors, many of whom are clearly quite naive when it came to investing their money, should have spotted the signs and that their losses are something they might have expected. But when a business advertises in a way that makes it appear that everything is above board, and claims to be properly authorised and professional, how can anyone tell whether it’s to be believed or not?
Here are ten tips for how to spot the deals that just might be too good to be true:
1. The Rule of ABC.
This stands for ‘Always Be Cynical’. Whether it’s high interest deposit accounts, bitcoins, gold bars or property-backed schemes, remember that there is no way that anyone can magic up financial returns well above those offered by the mainstream institutions without some risks being taken. Ask yourself, “If the best rate my bank can offer on my savings is around 2%, how can these people offer me 6%, 7%, 8% or more?”
2. Understand what you are buying.
If the investment you’re considering seems complicated or you don’t understand how it works, back off. Leave sophisticated investments to sophisticated investors or go on a course to learn what it all means.
3. Do your research.
The internet is a fountain of information and it won’t take long to come up with some in-depth comments and information. For example, about 15 seconds after typing ‘mini-bonds’ into my search engine I found an article containing the following observation;
“The high rates of interest are necessary because investors are vulnerable if the borrowing company gets into financial difficulty. Bondholders are at the back of the queue of creditors if the company folds. And unlike traditional corporate bonds, mini bonds cannot be traded. This means that they don’t have to provide as much information to investors (and you can’t sell them on).” 1️⃣
This says it all, really.
4. Be very aware of ‘confirmation bias’.
This is a well-known human trait, and it means that when we believe something to be true, we seek evidence to support our belief and ignore facts that suggest an opposite view. You need to take your emotion out of the situation and seek only facts, while continuing to be open-minded about them. Remember Rule 1.
5. Don’t put everything into one investment.
Ask yourself, “If this does prove to be too good to be true, can I accept the possible loss I will sustain.” No wise investor puts all their precious eggs in one dodgy basket.
6. Check out the investment forums.
There’s a lot of crappy advice and misinformation out there, but there is also a lot of wisdom. See what’s being said about your chosen investment.
7. Make sure it’s properly regulated.
This is so basic it shouldn’t need saying, but it’s clearly something that very few people take the trouble to do. The Financial Conduct Authority has a register of authorised firms that you can analyse, as well as a consumer helpline for this type of enquiry. You might also want to check out their long list of firms to avoid at:
Whatever you do, never do business with any firm offering you investments from outside the UK. The amount of money people have lost to overseas scams is beyond belief, and it grows daily.
8. Use an adviser.
There are plenty of reasons to use a professional financial adviser to help you make good decisions about where to invest. Not least of these is that if you get bad advice, you’ll have a source of redress against the adviser. Regulated financial advisers in the UK need to be qualified to a high level these days, and they will be able to interpret your suggested investment and explain the risks.
9. Accept that there is no ‘quick fix’.
It is possible to make a lot of money fast (as any Lottery Winner will tell you) but the odds are seriously against you. We’ve helped make a lot of people wealthy over the years, but we did it by using time-proven methods that work over time – often lots of time.
10. And finally….
One of the best lessons we’ve ever learned about how to become wealthy is that it’s not about how much you make, it’s about how much you don’t lose. Do you realise that if you lose 20% of your money on a bad investment you’ll need a return of 25% on what’s left to get back to where you started? The ups and downs of markets are one thing but throwing money down a bottomless pit because you didn’t follow these rules is quite another.
If you need help let us know and our Team will do our best to point you in the right direction.
Written by Andy Jervis, Certified Financial Planner
1️⃣ Jackson, R. (2019). Beware of the risks when investing in mini bonds - MoneyWeek. [online] MoneyWeek. Available at: https://moneyweek.com/497954/beware-of-the-risks-when-investing-in-mini-bonds/ [Accessed 18 Mar. 2019].