Spoiler Alert: I do not have the magic formula that is going to save you 100% of the time, other than use your brain and common sense.
Recent events brought me to write this post. Ben Carlson is a portfolio manager, a blogger, a podcast host, not a friend of mine 🙁 and most recently the author of this book:
As you have might understood, I follow his content and due to the book release he talked about scams quite a lot in the last few weeks. If you combine this and the various Kuetzal, Envestio, general p2p news, you can imagine why this post jumped in front of my list to do.
The main reason I write this blog is for myself, to put down my thoughts and ideas so that I can be accountable for them, I can revisit them and hopefully learn something in the process. To be honest, when I read about Kuetzal and Envestio I thought only gullible people would have fall for them. Then I transferred some blood from my guts to my brain and my thinking changed: I am over 40 and I spent more than half of my life obsessed with financial markets, would I have skipped the investment when I was 20? What type of lesson can I learn from these events?
Making financial errors (like investing in Kuetzal) when you are young is better than when you are old: the money involved is less (unless your parents established a trust fund for you) and you do not have the responsibility to provide for a family. You can lose your capital without consequences and hopefully learn a lesson that will help you later. It is actually more dangerous to trade and make money in your 20s, because you will then feel you know-it-all, only to lose way more later.
Being skeptic and cautious saved me from various bad investments/scams but there is a big downside: sometimes you miss really good opportunities. The first time a friend told me about Airbnb ages ago I thought there was no way any sane person would let a random group of people to sleep in their house; no, I did not have the chance to invest in Airbnb but if I had, I would have pass for sure. I did not invest in Revolut on Seedrs when I had the chance (and I love the product!). The year Facebook went public, my employer had shares that an investment bank sold to them before the IPO: I urged them to sell after the IPO because the company valuation did not make any sense to me. To invest in a game-changer company you need to believe and challenge how you saw the world since, but not believing is what normally saves from scams. Finding the right balance between the two is hard.
Doing the right amount of due diligence for an investment is hard not because it is a complicated task but because it is really boring. On the other side, scams are prepared by marketing ninjas, people that re-iterated and refined their process many times. “If you do not buy a ticket you cannot win the lottery” is a great marketing stunt, it makes you fell you have a chance, while actually buying a lottery ticket increases our chances to win from 0% to 0.000000000000000000001%. We want to believe that we found this exceptional opportunity that is going to make us rich. Wealthy people are more likely to fall for scams because they feel already exceptional, in their mind it is obvious why they are blessed again with another opportunity. Successful stories, people winning the lottery for example, are reported everywhere, whereas in the majority of cases the victim of a scam feel ashamed and keep the pain for themselves: our perception is that success happens more often than failure.
We still have numerous examples out there of wtf investments; maybe not pure scams but still hard to believe anyone will go home with profits once everything is said and done (other than the Nigerian Prince offering you the fantastic opportunity).
I am not an investor in Crowdestor and I did not do any deep due diligence on the platform but let’s take this as an example, a project recently published:
They want to (partially) produce a movie raising debt with 18% yield and a buyback guarantee. I actually hope this is a scam because if there is anyone who genuinely believe that this is a viable way to fund a project like this…boy, we have a huge problem. There is nothing wrong in financing a movie but the way to do it is with an equity instrument, not debt. Why? Any movie has an ex-ante negative expected return: the majority of movies are loss making, they cost more than they gross in tickets and other revenues, and no one, not even ‘experts’, is able to forecast which movie will be a success and which will bust. The attractive aspect, similar to start-ups, is that sometimes movies not only turn a profit, they turn a big profit, multiples of the initial investment. This is why investing in a very risky project but with a huge potential upside is really dumb via debt: you still risk to lose all your capital but your upside is limited, at 18% in this case (or 30%, I do not know what is that additional 12% on the project page). The buyback guarantee is the ultimate bullshit: they are raising EUR 1.5M on Crowdestor in total and the fund that should back your investment is less than EUR 400k.
Another great example are HYIP; I actually discovered them via another p2p blogger, a shocking sign on how some people can be delusional while pretending they are helping others writing about financial education. Look at this Diversity Fund Club, their about us page is hilarious.
Unfortunately our experience was rather disappointing, the vast majority of these sites didn’t last too long and sooner or later closed down. In most cases they suffered from different kinds of financial trouble, there was even a case when the system was hit by a cyber attack and couldn’t resume business afterwards.
You do not fuc***g say. It is really ‘unlucky’ that those fantastic opportunities did not last so long, who would have expected financial troubles!
The most secure solution seemed to be diversification, splitting our capital into 10-15 different investment programs.
Yes sure, one investment with negative expected return will go bust for sure but if you create an entire portfolio of assets with negative expected returns…your result would be different? You just bested Markowitz, here your Nobel prize, congratz.
The F.A.Q. is equally good
We are a revenue-share based profit maximizer and advertising club renting high quality Profit Packages (PP) from the internet-based money earning sector. To rent profit packages in Diversity-Fund Club, each customer is entitled to receive a share of our daily trading profit.
Wait, what? They define themselves as ‘risky high yield investment program’ but then I do not see the risk part when they describe how the program works: you rent a package and collect profits daily, voilà!
Direct sales commissions – Promoting the Diversity-Fund Club Affiliate Program – We have the most lucrative affiliate program in the business and offer 8% commissions on all profit pack rentals of your personal referrals (1 level).
But mind you, they are not a Ponzi (as they say in f.a.q.)…even if you can earn via referrals…like a Ponzi.
Whatever they are, the whole thing does not make sense from a simple financial point of view. If you found a way to generate 7% weekly returns, why are you ‘renting’ away the opportunity? At this rate, you double your capital in just 10 weeks: if you have a problem, is that this profit capacity is limited, not to find anyone to invest along you.
Last example is TFGCrowd, in particular this real estate project. This is the hardest one to spot compared to the previous two because the website looks fresh and well done and there are lot of other RE p2p websites out there, so most investors are familiar with the concept and tend to pay less attention to details. Normally a RE p2p project is guaranteed by the property bought with the loan proceeds, in this case the ‘security’ is a pledge on the Real Estate company, with no further specs. There are pictures of an apartment but no mention of the address of the project apartment, nor other details: are they stock pics or do they really belong to the project? The buyback guarantee is similar to Crowdestor, a guarantee only on paper since the fund to back it is way smaller than the total loans raised by TFGCrowd.
So far, lot of sketchy details but why a scam?
The video is…a walk in the street?!? Why they do not go to the apartment? The project is rated 5 starts…but all the other projects on the platform as well, maybe TFGCrowd CEO is a Juventus supporter? Sorry, I just noticed these aspects and could not help myself, now the serious stuff. According to the description, the RE Company wants to pay ‘cash’ because they will get a discount on the property price but:
- more than a discount, there is a preference by the seller. In fact, in a market where there are more buyers than sellers, the highest bidder wins, cash or not cash. In a market where there are more sellers than buyers, everyone can (and should) negotiate the price down. The cash offer gets priority only when two bids are at the same level or the seller wants to close the transaction really REALLY fast.
- This is not a cash offer. The RE company is simply switching from a banking loan to a p2p loan; you can make a cash offer if you have the money when you make the offer, so to say, in this case the campaign is on for at least few weeks, so I do not see how can you have a cash offer.
- The loan amount probably covers c20% of the apartment value (if the apartment exist and this is not a scam): the mortgage process is lengthy when you ask for 80% of the property value or more; for such low leverage the bank is very fast because they do not bear a high risk.
- If you are a (serious) RE company that has already some properties, you have a banking relationship at the ready; this is only a problem if you are a retail investor or a company that is just starting (or a scam).
Ultimately, you should apply the financial scam acid test: do this deal make sense from a financial point of view? In this case, no. Why would the RE company pay c20% interest when mortgage rates are lower than 2%? The loan interest rate cost is €34k, which represent a 3,4% discount if the total cost of the apartment is €1 million; if you consider the p2p platform cost and that you reasonably want to keep part of the cash discount to yourself, you need the cash discount to be at least 8%. If the apartment value is lower, you need an even higher cash discount to break-even. Put all the above elements together, if this is not a scam you are partnering with someone that is not able to past Finance 101.
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