Over the 6 years of my investing journey so far, I’ve seen a decent number of examples of how people suffer significant losses of their investment capital. It can be due to company mismanagement and excessive debt. It can be due to buying way overvalued stocks. In more nefarious cases, it can also be due to fraud.
3 common causes stands out from these cases: Believing in Hype, Blind Trust and Pure Greed. Today, I will run through some Case Studies highlighting these causes and discuss how you can avoid these biases.
Believing in Hype
Companies love to sell dreams to investors and we suckers lap them up. I certainly was like that when I first started, given the way I made judgment calls based on stories in the past. Perhaps the purest example of hype is from IPOs.
The IPO Effect
In an age of so-called Tech Unicorns, whenever one of them goes public, there is much fanfare and hype surrounding their listings. The thing most people do with IPOs is to punt and hope for the best. They don’t bother to analyse the thick brick of a document called a prospectus and choose to come to an investment decision based on their gut or hype surrounding the company.
Facebook has done very well for its shareholders in its 7 year history as a public company, but I vividly remember the fiasco surrounding its listing. It was priced at USD38, implying a USD104m valuation and a PE of 85 times. When it came public, it was faced big question – Can you monetise your mobile traffic? Evidence at the time was that they could not.
This eventually led to the share price’s subsequent decline to a low of $18, a cut by more than half in value. IPO investors took a bath within months if you believed in the hype surrounding Facebook. Thankfully for them, Mark Zuckerberg eventually found a way, but you could have easily avoided the crash if you had done the numbers and recognised its overvaluation.
A more recent example of hype would be the Lyft IPO. The US based ride sharing company came public early this month to much fanfare as well. Touted as the first ride sharing company to go public. Unfortunately, if you had read the prospectus, you would realise that Lyft (and Uber for that matter) is not invest-able. It is loses more money as it expands and is not operating cash flow positive. As such, there is no sign of light at the end of the tunnel for Lyft.
The market recognised this and the share price has been performing terribly since it’s debut. Priced at USD72, it closed day 1 at a high of USD79 before collapsing to trade below its IPO price at about USD58 last week. IPO and Day 1 investors, people who bought into the hype, face a loss between 19 – 26% within 3 weeks of the IPO.
Side rant on ride sharing companies
It is difficult to make a case to invest in ride-sharing companies other than based on a hope that they’ll figure things out. Using the current business model, the more the ride-sharing company expands, the more money it loses. They have been able to survive so far thanks to venture capital backing. The IPO is essentially passing on the burden to the retail investors.
The main problem with ride-sharing companies is the lack of ”stickiness” or customer loyalty in their current business models. Consumers just book through the service that can get them from point A to B in the cheapest way. This means the only way to compete is through price wars and a race to the bottom.
The only path to profitability I see is if the ride -sharing industry becomes a monopoly or at best a 2 player oligopoly. With anti-trust laws in place, I doubt this will be allowed. As such, until the industry dynamics changes or until ride-sharing companies find a new way of doing business, I am staying away and maybe you should too.
Singaporean investors are quite susceptible to this, in my opinion. We grow up in a country that is safe and secure, believing that a higher authority (aka the Government) would protect us. We implicitly trust the system that is set up here. This trust even extends to finance professionals and fund managers, where we believe they will put our best interests first since they are “more knowledgeable”. Some even invest in companies because Temasek is invested in them and believe they will backstop the company.
This belief system has led to a sense of naivety and complacency in retail investors, which sometimes blows up in their face.
There is no better example of this than the ongoing Hyflux saga. The once much vaunted example of Singapore entrepreneurship is going through a battle for its survival which may end in liquidation and bankruptcy. This is a classic example as it shows the level of trust investors had at every level of Singapore’s financial system. Here is a quote to illustrate this.
We invested in Hyflux because government support for the company was very strong. We invested because Temasek had invested. And Temasek must have done its due diligence.
When banks sold the securities to us, they told us ‘Temasek invested, so don’t worry. And if you don’t buy, somebody else will.
Investors went in because it was a national asset.Madam Chua, Hyflux CPS investor
This quote pretty much sums it up. Government invested, DBS is pushing it, water is a national asset so there will be an implied Government backstop. There’s even straight up misinformation saying Hyflux is invested in the company, something that could be easily refuted. All this didn’t prevent the company from crashing though.
As a side note, I hope everything turns out well for Hyflux investors.
This cause is probably the most influential cause for people to abandon logic and be susceptible to fraud. This is why fraud schemes like Ponzi Schemes never go out of fashion.
The never-ending cycle of Ponzi Schemes
Ponzi schemes are a form of investment fraud that pays earlier investors from funds of new investors. It works by taking your money to buy a certain asset (Gold, stocks, durians even) and promising you high returns. The hope is that these high returns will generate a huge amount of interest and more investors.
These schemes are highly dependent on the ability of the scheme creator to attract new investors to finance the scheme. As the investor’s funds are not used to invest in assets to generate returns and promised returns are too difficult to sustain, the scheme eventually collapses, usually with the scheme creator running away with the funds.
Ponzi schemes have been around since the 1920s and people to this day are still susceptible to them, which is so frustrating to me. Scheme creators have evolved with the times and re-skinned them to the fad of the day. Here is some recent examples of Ponzi schemes:
- Gold Buyback Schemes – Investors buy gold bars under the promise that company will buyback at a huge premium at the end of the contract period.
- Durian Investment Schemes – Investors buy Durian saplings and the company promises to pay your huge yields over the period of the contract.
- BitConnect – A Bitcoin lending scheme where you deposit BitCoin (in exchange for BitConnect tokens) on their platform and promises to pay you high returns monthly in the form of interest.
What you can do about it
The fact that we live in a treacherous system is the main reason why I feel people should actively manage their own money. The person you outsource to may not be acting in your interests and to me, the cost of their services is way too much anyway. These investment losses could have been avoided if you do the following:
Take charge of your own finances
I know most people cannot be bother to be very involved in managing their own finances and choose to rely on advisors and managers instead. I honestly find it illogical to do so when there are low cost and passive ways to grow your money (through index investing). In-sourcing financial management also helps you get educated and be less likely to be taken advantage of.
In a world that is out to get your money, only through education can you be aware of the pitfalls. Read books and financial blogs to get started. Go for courses if necessary to learn more. Decide on a investment pathway that suits your needs and personality. Stick to it and avoid what you are not familiar with.
Remember, ignorance is what breeds opportunity for predators.
Ditch the reliance on a stamp of approval (from the Government, Regulator, Advisor, Auditor, etc) before investing. Treat the advice you get from your financial advisor / relationship manager / insurance agent with a giant pinch of salt and read through all the paperwork. Perform your due diligence before investing. Be on alert for excessive guaranteed returns.
Fiercely guard your hard-earned money and you will not be taken in by fraudulent schemes.
The financial industry is set up to make money from the ignorant. Only when you take an active role in managing your finances and choosing to get educated can you avoid believing in hype, blindly trusting the system and being greedy. It is not an easy path, but certainly beats being taken for a fool.
If you missed my last post
Keppel-KBS US REIT 2019 AGM Highlights.