Waxingandwayneing’s Weblog

July 13, 2008

Return…………….and then the Risk

Filed under: The Economy — waxingandwayneing @ 11:43 pm

So many people seem to be chasing that brass ring, that above-market rate of return that others don’t seem able to achieve. People ask me, “So what do you think of those hedge funds?” Or they tell me that they are thinking of investing in a venture that promises to pay a 16% dividend each year for 20 years. Even simpler, why not put some idle cash into an Indy Mac money market that ispaying 75 basis points more than any other bank’s monthly market account? These higher returns seem so nice….so much better than the rates being offered by other institutions.

Sure they are. That is, until the inevitable reality sets in. They are paying higher rates of return for a reason. They are riskier investments. They are paying you more money to compensate you for the fact that you may not get your money back. Then why is it we always talk about “Risk and Return”, when we actually live in a world of “Return…..and then the Risk?”

In the financial world, we act more like a horny teenager on prom night–unconcerned about getting his date pregnant and focused solely on delivering the goods–than someone who cares that there will be a tomorrow to worry about. We constantly chase the rate, seeking out the better return, without much regard for the risks involved. Typically, we tend to minimize the potential for risk, arguing propensity, or rationalizing that someone will rescue us if necessary.

We need to get to the point in this country where we are responsible for our own decisions–financial ones included. If you put money above the FDIC limit into a bank or thrift that fails, you stand a good chance of losing that money. Don’t petition the government for help. You should have known the rules.

If you don’t fully understand the risks of a particular investment, then stand down….don’t invest. Most investment products are complicated and complex for a reason. The principals will come out just fine, win or lose. They don’t tell you that in bold writing, but it’s all there. Do you really think they are compiling all those documents to protect your interest? Please!

Were you surprised that Indy Mac didn’t take out full page ads that said: “Our rates are the best because we really need your money right now and we might not be able to give it back to you, but we will still be paying our executives a lot of money”? They were offering you a nice return……..and then they were presenting you with a lot of risk. Go figure!

Just remember: In business, politics, life in general…..If something sounds too good to be true, it probably is.

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