The too good to be true paradox !
Let me talk about a very common trap " the to good to be true paradox". It's a paradox, because most of the people are suspicious about that kind of products but some investors are uncontrollably attracted in the trap to invest their money for a hope of blue-sky result.
Definitely too good ....
1. It was not a scam but clearly an unrealistic offer
Kauphting Bank's case :
A lot of people lost money because they trusted and couldn't imagine that Kauphting bank could fail. People were looking for a safe investment that gave a better return than the interest rate provided by the competitors. At that time, short term rates were around 4% and some people invested their money in the Icelandic Kauphting bank that offered 4 % + 2 %. Who could not be interested by a short term investment with a higher return...yes but that bank was collapsing. So be wise when a financial institution offers you a much better return than the market there are maybe some reasons. In any case if you have a higher return you'll take more risk...
2. The practices of the Ponzi scheme
The recent Bernard Madoff's story:
A fraud relied on 3 pillars:
People feel they are exclusive investors selected by the con.
You have to invest a minimum amount but because it's you, that amout will be exceptionally reduced.
You'll benefit of an incredible perpetual return, in this case it was 10 % per year !
Sentence: in 2009 Bernard Madoff was sentenced to 150 years of prison for a..64 Billion USD fraud and 4.800 clients impacted.
That fraud was based on the well-known Ponzi scheme which comes from the story of Charles Ponzi who in 1920 in Boston conned investors into giving him millions of dollars, and paid them returns with other investors' money as simple as it was.
The 6 signs of a scam: All those different practices are working on a particular scheme desribed by the SEC (stock exchange Police in the USA)
It's an exclusive product (only for you)
High investment returns with little or no risk. Every investment carries some degree of risk, and investments yielding higher returns typically involve more risk.
Overly consistent returns. Investment values tend to go up and down over time, especially those offering potentially high returns. Be suspect of an investment that continues to generate regular, positive returns regardless of overall market conditions.
Secretive and/or complex strategies. Avoiding investments you do not understand, or for which you cannot get complete information, is a good rule of thumb.
Issues with paperwork. Do not accept excuses regarding why you cannot review information about an investment in writing. Also, account statement errors and inconsistencies may be signs that funds are not being invested as promised.
Difficulty receiving payments. Be suspicious if you do not receive a payment or have difficulty cashing out your investment. ex: Ponzi scheme
3. It's not a scam, not even an unrealistic offer but it's still too good to be true..
Be careful with some structured products:
Some very complex structured product are offered by some cupid financial institutions to their clients. When you look at the product they appears like defensive and secured products. They are, but if you look into the details you'll find that the real and only beneficiary of the product will be the distributor of the product. Why ? Because most of the time it's a capital protected product that you have to hold for a long time through sometimes costly conditions:
High level of entrance fee (from 0 to 5%)
You want to sell the product before maturity, it's not a problem but will pay costly decreasing (mostly) exit fees that can start at 5%
a Management fee will be perceived each year.
and last but not least the underlying product could be a fund managed by..the bank means also new management fees !
Knowing that who will be following you the real beneficiary of that investment..the investor or the bank? So have a close look at the notice before you sign.
There are many other scams or suspicious offers. Thanks to those past misfortunes the financial authorities have developed procedures to protect the consumer against that kind of practices. So don't hesitate to refer to them in case of doubts (FSMA in Belgium - SEC in the US etc).
If it is too good to be true...then probably it is! That must be you first reflection when someone propose you that kind of product that offers you in a safe way a better return than comparative products in the markets.
Sébastien Van Passel