We all know there’s an apparent link between risk and reward, or the opposite of reward. If you’re prepared to stake money on the spin of a roulette wheel, you should be prepared to lose said money very quickly. If you put money in the bank, you’ve got a reasonable expectation of capital security and modest returns.
For the vast majority of retail investors, the risk and reward chart does not include a trip to the casino or horse races. Why would you dream of exposing your hard earned money to such a significant risk?
What most investors think they want, in my experience, is lots of capital security combined with high returns. As professional, experienced advisers, we know this is impossible. You can’t break the link between risk and reward. As soon as you try it, you introduce different risks, which are often harder to see or understand.
Despite our understanding of this unbreakable link, many investors lack the same knowledge. This makes them easy targets for the sort of financial promotions that promise the world and often deliver crushing losses.
Take London Capital & Finance, for example. We could all see it was anything but ‘low risk’. Nearly 12,000 people thought it looked like a good prospect and handed over £230m of their cash. To quote one of my favourite lines from the cartoon South Park, when one of the children entrusts his pocket money to the bank, “Aaaand It’s Gone”.
Except it might not be gone. In addition to any sums the administrators can recover, the prospect has now been raised that the Financial Services Compensation Scheme could open its doors (and bank account) to compensation claims.
Compensating victims of this scheme is, of course, ridiculous. But a talented lawyer somewhere appears to have identified grounds for bringing this unregulated investment into the remit of FSCS compensation, so I guess that means we will all have to pay.
If this becomes the norm, we’re faced with a frankly terrifying situation where the link between risk and reward no longer holds.
It means investors can stick their money wherever they like, and win regardless of the outcome. In the rare event that the ‘low risk’ product delivers on its sky-high returns, they keep the winnings. In the more likely event that the promoter of the product hands a lot of the cash to their friends and family, the investors win anyway by getting their stake back from our FSCS levies.
It’s like being able to walk into the casino, put £10,000 on red, watch the ball land on black, and then get your cash back from all of the other casino operators. When a system like this is in operation, our UK financial services regulation is very broken indeed.
Martin Bamford FPFS
Chartered Financial Planner
Managing Director, Informed Choice Ltd