Can you really get 8% interest on your savings?

 

You may have recently read about the collapse of London & Capital Finance (LCF). Savers who were lured in by the promise of 8% p.a. interest put in £236m and the administrators expect as little as 20% of that back.

Risk loss written on dice.png

This is something we at Collingbourne have been expecting for a while now. There are lots of firms out there offering huge rates of return. All positioning themselves as cash like investments, or at least alternatives to cash accounts/ISAs.

Their adverts can be seen everywhere; online, billboards (I saw two new ones on my way into London last Friday alone) and TV. Even searching LCF online for this blog brought up their adverts.

They have a few things in common. Their ‘cash-like’ positioning, sky-high headline rates of return, underlying property investments/loans and uniformly positive reviews on Trustpilot/Reevoo etc. (as if they’d be anything other BEFORE it goes wrong, and people are still being paid those rates).

It is clear there were serious issues with LCF (dodgy deals with marketers, apparent broken FCA permissions etc.) and I am certainly not asserting other providers are the same and will face the same fate.

However, even where a provider is scrupulous and above board, risk and return are related.

Risk and return

If someone is offering high returns, there must be a reason. If an investment was low risk, it wouldn’t need to offer those rates – It could offer much lower ones and keep all the excess returns.

Eugene Fama, Nobel Laureate, frames it as: ‘the investor’s return is the company’s cost of capital’. A business/venture will try to raise finance as cheaply as possible; the cost they pay on raising that capital (be it interest on loans or equity stake sold) will be the return to its provider i.e. the investor. Basically, if you are being paid a rate of return, it means someone else is paying it, and again there has to be a reason.

In order to get an expected return above cash, you have to accept risk (you can of course obtain expected risk without additional expected return e.g. gambling). If and when that risk happens, all the Trustpilot reviews in the world won’t matter for much.

History repeats

Even just looking at the last 10 years or so, there are a startling number of examples: Bernie Madoff, Arch Cru, Key Data and any number of property vehicles (e.g. Sterling Mortimer) to name just a few. A fantastic amount of money has been lost as people, including many investment professionals (especially in the Madoff case) who should have known far better, have ignored the simple relationship between risk and return.

Conclusion

The old cliché holds true; if something seems to good to be true, it probably is. If something or someone is offering you a high rate of return, there is a reason. No matter how convincing the sales pitch or the marketing materials may be, remember, there is always a reason.