Too Good to Be True Is a Simple Reality

October 30, 2024

Investing

Sadly, I regularly hear of frum people who lost tremendous sums of money by investing in real estate syndications they didn’t understand. The offering memorandums they’d skimmed had been projecting returns as high as 25%, and the managers supposedly had track records of these phenomenal returns. But then, kaput! They get the dreaded email from the superstar manager that the deal they’d invested in had faltered and their money is in jeopardy. What happened?!

Beyond the Fluff

While I am a big proponent of real estate investments, I regularly caution my readers to be very careful about investments offering above average returns with below average risk. Someone who understands the investment world doesn’t need to spend a lot of time to know that something is missing in the fluffy marketing offering such opportunities. Because it’s obvious that, literally by definition, typical average investors need to make do with typical average investment returns.

A $10,000 Camry!?

Imagine that someone tells you, a regular consumer, he can get you a brand new Toyota Camry for $10,000. You’d be super skeptical, right? There is a strong, transparent market for these popular cars, and they sell for far more than $10,000. Just based on the price point, you would immediately understand that something was up. Either the car is not in new condition, or perhaps it is stolen goods without a clean title. Alternatively, the catch could be that the price would be jacked up close to the market rate somewhere along the line.

Why Me?!?

We all know that if something sounds too good to be true, it almost certainly isn’t true. But many investors, when they are offered such an investment, think that a fantastic opportunity just fell into their laps. I was once discussing this with a very savvy businessman and investor, and he told me his mentor trained him to ask, “Why me?” “If this investment opportunity is indeed so unbelievably fantastic, how is it that it just fell into my lap?”

It’s a Competitive Market

Let me expand on this a bit. Most people understand that there is a clear market for automobiles but don’t recognize that there’s also a very established market for investments. Someone casually offering you a low-risk, high-reward investment opportunity is as bizarre and unlikely as someone selling you a brand-new Camry for $10,000. Again, ask yourself, “Why me?”

Every day, thousands of investment professionals wake up and try to create opportunities they can profit from. Similarly, many investment managers are responsible for sorting through these investment opportunities and choosing the ones that fit their desired balance of potential risk and potential reward. While the market has variability, the intense competition and transparent marketplaces help keep a reasonable level of price efficiency. Finding an investment with above average reward for below average risk is very difficult!

Risk and Reward Are Strongly Correlated

Insurance companies that need to invest in very long-term, low-risk opportunities seek out high-quality bonds or make low-risk mortgage loans. Managers of stock mutual funds are looking to generate higher returns for investors willing to accept the ongoing volatility. They’re looking for companies with the greatest long-term potential, even though they recognize that a mistake can cost them dearly. And so on and so forth.
Sophisticated hedge funds control trillions of investment dollars as do endowment funds, sovereign wealth funds, and managers representing the world’s wealthiest families.

This is the marketplace for money, and while there are myriad levels of desired risk and reward ratios and the desirability of various investments can change, there is pricing competition. If someone is looking to lend money at a very low risk, he will get approximately X percentage; if someone is looking for a growth investment, he is looking for Y percentage, and so on. The company that can borrow money from a pension fund at 5% is not going to borrow from a different investor to pay 7%. Investing is a very competitive market.

Why You?!?

So, getting back to real estate. If someone can indeed reliably, with very little risk, generate 25% returns, they can easily raise unlimited funds from the money marketplace, which is always seeking to get the most return for the lowest risk. There’s no logical reason why somebody would offer run of the mill investors secure low-risk, high reward returns, just as there’s no reason for a Toyota dealer to sell you a brand-new Camry for $10,000.

Too Good to Be True

In reality, 99.9% of the time, there’s either far more risk under the hood or the potential returns are far lower than advertised. And while there are exceptions to every rule apply, finding .1% exception cases typically will entail a tremendous amount of work and effort. Securing a secure 25% return on investment is not something that just falls into your lap or is offered casually to random people.

Exceptions Apply

Now, perhaps you have a very close and trusted friend or relative who is a professional investor, and he offers you a low-risk, high-reward investment. Mazal tov. It’s possible you have access to the .1%. That is no different than a Toyota executive being offered a new car at cost price. There is logic there, too. But if someone would not give you a car for $10,000, he’s also not giving you a low-risk investment at 25%. And many people have lost money to these friend and family “specials,” too.

Fooled by Randomness

Some may counter that they know many people who invested with minimal research and they got 25% or even much higher returns. Indeed, in the post-covid real estate boom, many investors made massive windfalls. But that proves nothing. People win the lottery every day. Some people walk out of casinos with large profits, too.

The fact that an investment did very well does not mean that it wasn’t extremely risky. It is definitely possible for a very risky investment to return extremely high returns. Risky investments NEED to have that kind of potential to attract money from rational investors. But that fits with the overall concept of a competitive risk/reward marketplace, it is no exception to the rule.

Bursting Bubbles

Unfortunately, regular circumstances don’t bring us $10,000 new cars, and unfortunately, there’s no way for average investors to get low-risk, high-reward investments. I am sorry to burst your bubble, but wishful thinking can be super expensive in the realm of investing.