After some prolonged legal proceedings following Advanta’s collapse, there’s a new settlement whereby investors in their high yield notes will get 38% of the money owed. This follows months of warnings (April 2009, May 2009, Jun 2009 and then…boom!) from me highlighting that as the company continued to blow more and more money on ads (in my local newspaper at least) touting their high yield investment notes yielding upwards of 8%, the company continued to crater.
The message here isn’t so much to gloat and say, “I told ya so”… (well, OK, I am patting myself on the back a bit for hopefully saving thousands of people money since those articles used to get tons of hits)… but the message is the following:
If it seems too good to be true, it probably is.
OK, that’s lame. So, from an investing standpoint, (generally) markets are efficient (examples). If you’re getting 3% on a 10 Year Treasury and 2% in CDs while some guy named Stanford claims he can give you 8% on a CD (multi-billion dollar CD fraud), how does that pass the smell test? There’s either something illegal or very risky going on and it’s upon you to immediately notice that something’s amiss.
In the legal high yield segment, obviously, if a yield is high, it’s because investors perceive the risk as quite high. We’ve seen a ton of money pour into high yield corporate debt since income investors have few other avenues to even keep up with inflation. There’s a great article from Morningstar basically highlighting a study that demonstrates that investors who seek out high yield investments generally under perform safer assets from a risk-adjusted return standpoint. On one hand, you might say, “Who cares, I just want the best return possible”. Well, from an academic standpoint, and from a practical standpoint, returns SHOULD be commensurate with risk. So, when you take on inordinate risk and only have a shot at marginally better returns, your safer assets were actually a better investment on a risk-adjusted basis. In other words, would you rather have an FDIC-insured CD that returns 7% annually (guaranteed) or take your changes with the volatility in stocks for a “chance” at a long-term 8% return? I’d take the 7% any day. But it doesn’t exist risk-free.
I digress. To boil this down to a single sentence… If you chase unnaturally high yields, you’re likely to get burned.
Are You Chasing High Yields?
Are You Aware of Unconventional Investment Classes that Seem Too Good to be True?
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