There are so many offers floating around the financial services space – farms that grow seasonal crops are offering a guaranteed fixed return, companies trading in the currency markets with huge per second swings are offering guaranteed profits, online equity trading apps are offering guaranteed returns to investors, etc.
I want to address the issue of guaranteed returns, with a view to using that as a way to gauge offers in general.
First off, what is a guarantee? According to the Merriam-Webster dictionary, a guarantee is “an assurance for the fulfilment of a condition.” Thus, a guarantee “assures.”
What is a financial guarantee?
Simply put, it’s an assurance of a financial condition, usually a gain or protection from principal loss. For instance, a Guaranteed Investment Contract, “Guarantees or assures the owner a specific rate of return from an insurance company in exchange for a deposit.” A Guaranteed Investment Fund “allows its client to invest in equity, bond and/or index fund while providing a promise of a predefined minimum value of the fund (usually, the initial investment amount) [which] will be available at the fund’s maturity or when the client dies.” A financial guarantee is simply a non-callable promise to investors that stated principal and interest payments will be made.
When the phrase, “Guaranteed Returns” is used, the issuer of the investment promise is saying and giving an assurance that come what may, the promise made on returns (and principal) will be met. This is a promise, it’s not callable, reversable or negotiable.
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How do guarantees work in practice?
Well, there are basically only two types of investment products, Fixed Income for investments that offer fixed returns and Variable Income for investments that offer variable rates of return.
Fixed income products include bonds and mortgage securities issued by sovereigns or the private sector. All fixed income products offer an implicit yield when issued and investors are buying these securities to protect invested principal and earn a return. Fixed Income products usually have a sinking fund which is a separate account, usually managed by a trustee company, that receives regular payment from the issuing company. There contributions are pooled during the tenor of the bond and used to repay bondholder.
When investing in a fixed income product like a bond, especially issued by the private sector, the investors must ask:
- Is the bond “floating” or secured with assets?
- Is there a sinking fund set up to pool funds to repay bondholders?
- Is the sinking fund independently managed?
You want to get a solid “Yes” on all three.
What about bank-issued products?
When you deposit money in a bank, it’s insured up to N500,000.00 by the Nigerian Deposit Insurance Corporation (NDIC). So we can argue that the risk-free deposit level for any Nigerian bank is N500,000.
The NDIC does not cover all investments in the financial sector; investments in Discount Houses, Finance Companies, Investment Firms, Unit Trusts/Mutual Funds and insurance companies are not NDIC insured. This means you should do a lot more due diligence with investments issued by these firms.
Variable income products are investments whose returns are not fixed or whose implied yield cannot be determined at purchase. Equity-based investments are examples of variable return products when you buy a share of MTN, you cannot determine with any certitude the return on your investment in 12 months; keep in mind that “past results of any stock of fund is not a guarantee of future returns.” Simply put, equity prices and returns are based on projected cash flows and earnings in the future. Because no one can predict the future, it follows then that no one can guarantee returns.
Let me be specific with two commodities I have seen over and over being packaged as “investments” i.e., Currencies and cryptocurrencies. The price of these commodities are based simply on demand and supply, nothing more. If more people buy, prices will rise, if demand falls, prices fall. These commodities have no intrinsic value, currencies are based on the full faith and value of the issuing government. No one can project demand, but anyone can gamble and take a position on expected rise and fall of demand. No matter how these products are marketed to you, once it involves trading in cryptocurrencies and currencies, you are essentially gambling. With gambling, there are no guarantees. I’m not suggesting that they are illegal, gambling is legal, I am asking you the investor to be aware of this, and take enough risk management procedures.
When you as an investor get an offer, and the vendor offers you a guaranteed return, what questions should you ask?
- Is the firm registered with Corporate Affairs and the Securities & Exchange Commission? You want to know if the owners have been vetted. If they have share capital, and if are playing by regulated rules. But go further.
- How is that guarantee being funded? If a farm promises you 20% from the sale of maize in the future, how do they guarantee that 20%, if the crops fail? Do they have a sinking fund? Is your guarantee in writing, with unambiguous language that guarantees a return to you at a set date and set return rate?
- Is the guarantee backed by any third party? The farm has a bank that receives sales proceeds; can the farm get its bankers to issue a bank guarantee on that written promise to pay you, the investor, 20%? Ask questions…
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Essentially, remember this
Gambling simply means volatility. If you have the risk-free rate at 12% to 14% via Federal Government Bonds and you receive a “guaranteed” return of 15% a month i.e., 180% a year from a product that trades in cryptocurrencies or currencies, understand that what is being offered is not an investment at all, but a trip to the casino – no difference.