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What are some questions to ask when tempted by a 12% yield?

Wednesday, May 27, 2015

A conversation with a reader on a type of investment that I am usually wary about:

Hi AK,

I am looking for financial freedom but having little investing knowledge. I have a little situation...

About few months ago, I chance upon a company call XXX that was into Aquaculture business in a investing seminar. I was hooked by their business model in the way the speaker was presented as it was easy and simple to understand. They farm mud crabs and fishes and sell to local market.
Investors that throws in the money get back their profits, very simple.

 They offered me 8% of guaranteed returns on the every 8th month if I were to invest SGD $2500 with them. The investment will end on 24th month. Having no basic knowledge of investing, I agreed and invested my money with them.

8 months has past, I received a call from the company and the portfolio manager invited me to his office to collect the returns generated from the business in a form of cheque and to meet me to talk about  further expansion of their business.

I went over to meet the portfolio manager in their office, he pass me my cheque. This time he explained that their company wanted to raise capital for expansion on a greater aquaculture sector and further explain that it is a stand-alone bond. This time the minimum sum of amount to invest is SGD $25,000 in the bond with a fixed return of 12% that will be given per annum that will stretch out to 5 years. There is a early exit in the 2nd year, however if I placed my money til the 5 year I will have my ROI and a maturity bonus. Total ROI that I will be receiving will be $16,875 if i keep til the 5 year.

 He showed me that they have a strong team of Aquaculture Researchers and specialists in his power point slides and pictures of them.

I'm very uncertain about placing $25,000 to Aquaculture investment as it is a very risky investment.

I would like to know that do you think of this type of investment?





My reply:

Hi,

1. Why is the business not able to get a bank loan?
 

2. Why is the business not able to get the backing of bigger investors?
 

3. Surely, it is a lot more work and costlier to seek out many small investors.

I did some research into the company. They claim to be a global company and the only reason I can think of for doing what they do to raise funds for this business is because it is a high risk business. I wonder if they have a credit rating?

A coupon of 12% per annum might seem very attractive for a bond but this is what is offered by junk bonds issued by companies which fail to secure a strong credit rating.

In fact, many junk bonds offer much higher yields now. 12% could be insufficient to compensate lenders for the risks they are asked to undertake. Have they listed the risks associated with the business? What are the things that could go wrong?

Do insiders have a big personal stake in the business? Or is the business being run solely on borrowed funds? How are they able to guarantee the safety of your capital invested if the business should fail?

I don't know enough to invest in something like this with confidence. So, I would rather avoid.

Best wishes,
AK


I know I have asked many questions in my reply to the reader but that is really the first thing we have to do as investors: Ask questions which matter.

It is not just how much money could we make but also what are the chances of us losing money and how much could the losses be?

Related post:
Nobody cares about our money more than we do.


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