Unless your age is in single digits, you’ve probably figured out that unicorns don’t exist — but that doesn’t stop many of you, even those with advanced degrees, from searching for what I call the investment unicorn. Perhaps it’s human nature to thirst for things that are improbable, such as being able to eat anything you want but still lose weight, but I simply marvel at investors who truly believe they can earn high returns with low — or no — risk. That’s a unicorn!
This true story illustrates my point perfectly:
A few years ago, I received a call from a potential client who was without-a-doubt hunting for a unicorn. A Ph.D. who certainly wasn’t stupid, he told me he was seeking an investment that would earn him 2 to 3 percent per month — and he couldn’t afford to lose any of his principal. I was flabbergasted. Not only was he seeking a totally unrealistic return of 25 to 40 percent per year — he was unwilling to accept any risk to try to reach his goal.
This gentleman did not become a client because we’re not in the business of filling portfolios with unicorns. Our job is to decide where clients fit on the risk versus reward spectrum and counsel them accordingly.
Risk Versus Reward
Risk and reward are always related; it’s a fundamental principle of finance. If you want a high return, you must be able to accept the risk of loss that goes along with that investing strategy.
There simply is no bargain bin in the investment world. Consider this: if your advisor came upon a unicorn — something that offered high returns with low risk — why would he sell it to you? Wouldn’t he reap the benefits and retire to a tropical island?
Remember Bernie Madoff? He sold the promise of 1 percent monthly gains to thousands of investors who were looking for unicorns — and you know how that ended.
I speak with many investors who don’t want negative years, months or even days. In the world of investing, there is simply no such animal if you’re seeking a high return for your money. You’re unicorn hunting.
The safer the investment, the lower your return. That’s why we tell our clients to save like crazy during their prime earning years, because they need a big pile of money as they move closer to retirement or have already retired — when they can’t afford a lot of risk.
Some people consider annuities to be unicorns since they are a low-risk investment that can offer a high return, but there are some strings attached to them. You usually need to lock in your money for at least a decade, so it’s unavailable to you, and you may be charged when you want to access it.
There’s simply no “free lunch” for investors, but the good news is that when you invest in public markets, you typically get what you pay for — and a good combination of risk and return. Plus, markets correct almost immediately when risk versus reward gets out of sync.
Take this example:
Let’s say $100 bond is available that offers a 10 percent annual return, or $10. Since the issuer is the U.S. government, there is no chance of default.
Investors will immediately bid up the price of the bond, thereby reducing the 10% return in the future significantly for all but the original owner, who will get a windfall. In the real world, this windfall doesn’t exist because the bond is issued with much lower rate initially.
The moral of the story: don’t sabotage your future by continuing to hunt for unicorns or falling prey to those who would make you think they have one. Fairy tales make great bedtime reading for children; they have no place in the investment world.
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