Know The Investment Risks You Are Assuming

I am constantly amazed at how so many people look for the quick and easy way to get rich without truly understanding both the RETURN and the RISK aspects of an investment opportunity. It doesn’t take long to perform a quick internet search to come up with examples of investors who overlooked the inherent risks of the investments they made because they focused on the “supposed” returns.

In some cases I really can’t help but feel truly sorry for those who lost money. You read stories of this nature and you wonder why is it so difficult to pass rules and regulations that have teeth so that “investment advisors” can be prosecuted more quickly and face stiffer penalties.

You then have other investors who pursue a different avenue in the hopes of generating wealth…at the expense of less fortunate individuals. Take the example of Lending Club (NYSE: LC) which went public in late 2014. On its website (www.lendingclub.com) bills itself as America’s largest online marketplace connecting borrowers and investors. It purports to:

  • be transforming the banking system to make credit more affordable and investing more rewarding;
  • operate at a lower cost than traditional bank lending programs;
  • pass the savings on to borrowers in the form of lower rates;
  • provide investors with solid returns.

Really? How’s that working out so far? Look at the company’ stock chart and read this story.

What irks me is how the former CEO of Lending Club can do what he did without any repercussions. Countless investors and lenders have taken beating yet he walks away from the quagmire and sets up a rival company within the year. I‘ll bet my bottom dollar this guy ultimately intends to take his new company public and another batch of investors will get suckered under the illusion of double-digit returns. I certainly cannot foresee the future but I suspect those investors will also get burned.

You also have investors who have been lured into investing in Mortgage investment Corporations (“MICs”). MICs are alternative fixed income investments which have become increasingly popular because of their sustained double-digit returns; it is quite normal for MICs in registered plans to achieve 9% – 14+% rates of return. Investing in unregulated MICs is certainly not for the faint-hearted and in my opinion, should be restricted to sophisticated accredited investors (not just accredited investors!).

In this low-interest rate environment you would think that investors would question the risks associated with MICs. Nope!

Look at the following document published by the Canada Mortgage and Housing Corporation (CMHC).

CMHC Mortgage Investment Corporations – Risk Profile (August 2016)

If you are wondering about the credibility of the agency which published this document, rest assured the agency is credible. As Canada’s national housing agency it:

  • contributes to the stability of the housing market and financial system;
  • provides support to Canadians in housing need;
  • offers objective housing research and advice to Canadian governments, consumers and the housing industry.

While there are undoubtedly several good MICs in which to invest, there are many that really should not be around. The number of MICs has increased over the past several years to the extent where MICs are struggling for a share of a market that is not growing in lock-step with the increasing amount of mortgage money available through MICs and institutional lenders. Several years ago, it was easier for a MIC to place money in secure mortgages. Today, competition for good mortgages is fierce.

Some investors seeking to improve their return on investment in this prolonged low-interest rate environment have probably ventured a bit further on the risk spectrum than they truly understand. When we eventually experience a correction in real estate values I think several MICs are going to get hit hard and some investors are going to suffer significant losses. I sincerely hope you are not one of these investors.

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