EVERYONE likes to see their money grow and we like to think fixed interest investments are a safe and stable option. However, in chasing the highest interest rate you may actually be doing yourself a disservice. Returns of 12-17% may look attractive but on closer inspection their financial logic starts to crumble. If you’re after security, it pays to look beyond the percentage.

According to the Australian Securities and Investment Commission, any product offering more than 2% above the established rate can be considered unrealistically high and will most likely involve a disguised level of risk.

So before you pour your life savings into what appears to be a lucrative “can’t lose” investment, it’s worth asking how much you actually know about what will happen to your money, because what you don’t know definitely can hurt you.

How safe will your money be?

In the past six years, ASIC estimates that at least 6000 Australians have lost around $500 million of their life savings chasing high returns. Unfortunately the biggest danger sign is the promise of a better return than you can get anywhere else.

Although high risk does not always equal high return, as a rule of thumb, high returns more often than not involve a higher level of risk.

Nearly everyone has at some stage earned regular interest on their savings account or legitimate fixed interest investments. But unfortunately the perceived stability and familiarity of fixed interest yields can sometimes bait unwary investors into more dangerous products.

If a fixed interest rate is being offered by a private company or an institution you do not immediately recognise, that is a clear warning that you should either steer clear or be prepared to do a lot more research.

Simply trusting the salesperson can lead you to into losing a lot of money, and if you borrow to invest, you can easily end up owing more than you have.

What do risky high interest investments look like?

You’ve probably already come across them advertised in reputable newspapers, or investor magazines – brightly coloured advertising offering superior returns on cash investments, some as high as 17-25%, and a tollfree number to call.

These advertisements are paid for by building developers or companies who, unable to acquire sufficient capital from the banks, turn to private cash-rich investors to fund the gap on their next project.

They’re not a scam as such; projects that go well can also make investors and venture capitalists very wealthy. However, they do represent significant risk and should only be entered into with a thorough understanding of the project and the risks involved.

Debentures and mezzanine lending

Debentures are one way that businesses raise money from investors. In return for your money, the business or issuer of the debenture promises to pay interest and eventually pay back the capital you lend them at a later date.

Your money can be used for a wide range of business activity, from paying wages through to lending it to another business or “on-lending”. However, unlike a term deposit, the interest payments on you money and the return of your capital are not certain.

Mezzanine investing exists outside of the strict financial services law that protect investors in superannuation, managed funds and shares. It involves putting your money into ventures financed partly or entirely from outside the mainstream financial markets.

Although technically legal, the law assumes you know what you are doing and understand the risks.

In nearly all high interest yielding investments, private investors are called on to cover the shortfall in investment capital when banks refuse to offer further funding. And this is the key point, investors are asked to put cash on the line when experienced bankers consider it too risky to offer the full amount.

Developers would not be paying 12-17% interest if they were able to get it at a lower rate from an institution.

2 questions every aspiring venture capitalist should ask themselves

1. Do you really understand what your money will be used for?

If you have difficulty explaining the business model to a friend, or you are unclear as to what your money will be financing, this is a sure sign that you should stop and seek advice.

Ask for a prospectus and go through it with a fine-tooth comb, and if it still sounds too good to be true, it probably is.

2. Can you afford to lose the money you’ve invested?

A lot of these schemes claim you can’t lose, but when they fail the results can be devastating.

There are infinite variables that can affect the success of a project, from management and compliance through to building practices and market fluctuations.

If the project is mismanaged or fails, you need to ensure you are adequately diversified and not resting your entire financial future on the success of a single venture.

Of course, many projects do succeed, and experienced mezzanine and debenture investors can make a lot of money. However, experienced investors fully expect some of their projects to fail or perform poorly, so they spread their money across various projects and different project managers.

It takes years of experience and usually a financial background to help them recognise and avoid bad deals.

Do your research and, if in doubt, seek advice because investments promising attractive percentages and continuous above-market performance may not really be in your best interest.

Send to Friend

Printable Version