Would you invest in this?

[mikaty]

Hi fellow Mustachians

I have an opportunity to invest in a fund that offers some unique guarantees...

Basically it's a 5 year investment in a fund that invests in S&P 500 and Euro Stoxx 50 indices. At the end of the 5 years:
If the overall portfolio return is positive, they guarantee a return of 100% on your capital investment.  If the overall portfolio return is above 100% you get the actual portfolio return.
If the overall portfolio return is negative then 100% of your capital is protected for a fall of less then 50%.  If the fall is 50% or more then the captial protection does not apply.

One thing, the fund only takes into consideration actual growth on the index.  Any dividends are excluded as that is what is used to pay the guarantees.

There are no recurring fees although there are some initial investment fees of 1.75% of the investment plus taxes.

There are other incentives to boost your initial capital investment if you have some other products with the same company but for the sake of this discussion I'm going to ignore those.

The company offering this investment is well-established and has a very good reputation.  I currently have some retirement investments with them and have not had any concerns with the way they operate.

Would you invest in this - and if not why not?

I'm on the fast track to pay off my house and emotionally don't want to delay that, but this is a limited time offer and logically I think it makes sense to do this. 

Stop me if this sounds like a huge mistake

[BFGirl]

So basically they charge you 1.75% to use your money for 5 years so that they can invest and keep the dividends?  The only upside is you break even if the price falls less than 50%.  I wouldn't do this.  It sounds fishy to me.  I think you would be better off investing yourself.

[mikaty]

Hi BFGirl

Sorry maybe this was not clear.

If the fund is positive at all the return is guaranteed to be 100%, so you get double your initial investment back. 

[johnintaiwan]

It sounds like they are planning on picking stocks they think will be going down buy maybe still paying dividends. I have no idea about stuff like this but that seems to me the only way they would benefit at all. I would be careful. a 100% return is pretty crazy. I dont see how they could possibly pay that. Even if they keep your dividends, if the fund goes up 5% they need to come up with another 95% increase to pay you.

[warfreak2]

There is something wrong here.

Not as wrong as some of the other posters seem to think, but wrong. 100% total return over 5 years is not that uncommon for the S&P500, and if the price growth is below 100% then they are profiting from the dividends. Dividends actually account for rather a lot of the long-term growth of a stock market investment! But 5 years is not very long-term, and it seems that the dividends do fall a little short of covering their guarantees. You do have to actually do some maths to check this, it's quite close!

Over 5-month rolling periods for the S&P500 beginning every month since 1950 (that's what I have data for), this investment would return on average 84.3% after fees, equivalent to an annual return of 13%. The average annual total return of the S&P500 since 1950 is 11%. That extra 2% may not seem like much, but it does show that on average they can't pay out on their promises just by investing in the S&P500.

Now, this data doesn't include the Great Depression, but even if the S&P takes an enormous 50%+ dive, they still only get the 1.75% fee. Even then, whether or not it was profitable for them in 1929, it's been unprofitable to offer such an investment for at least 64 years, so one has to wonder why they are offering it and how they're guaranteeing it - the dividends are historically not enough.

This suggests to me that there is something missing, perhaps more fees, or a mistake in the payout structure.

[hodedofome]

There is something wrong here.

Not as wrong as some of the other posters seem to think, but wrong. 100% total return over 5 years is not that uncommon for the S&P500, and if the price growth is below 100% then they are profiting from the dividends. Dividends actually account for rather a lot of the long-term growth of a stock market investment! But 5 years is not very long-term, and it seems that the dividends do fall a little short of covering their guarantees. You do have to actually do some maths to check this, it's quite close!

Over 5-month rolling periods for the S&P500 beginning every month since 1950 (that's what I have data for), this investment would return on average 84.3% after fees, equivalent to an annual return of 13%. The average annual total return of the S&P500 since 1950 is 11%. That extra 2% may not seem like much, but it does show that on average they can't pay out on their promises just by investing in the S&P500.

Now, this data doesn't include the Great Depression, but even if the S&P takes an enormous 50%+ dive, they still only get the 1.75% fee. Even then, whether or not it was profitable for them in 1929, it's been unprofitable to offer such an investment for at least 64 years, so one has to wonder why they are offering it and how they're guaranteeing it - the dividends are historically not enough.

This suggests to me that there is something missing, perhaps more fees, or a mistake in the payout structure.

Agree with Warfreak. A 100% return in 5 years is 14.87% CAGR per year. That's a pretty big assumption they are making and I don't know how they can guarantee you that kind of return. If it's too good of an investment for you, then that means you are screwing the counterparty. If they get screwed, will they pay? What is the guarantee they will pay you? Is this some sort of annuity or life insurance product? I'm confused that someone would offer this in the first place if they are actually legit and plan on being around for a long time.

[rmendpara]

Hi fellow Mustachians

I have an opportunity to invest in a fund that offers some unique guarantees...

Basically it's a 5 year investment in a fund that invests in S&P 500 and Euro Stoxx 50 indices. At the end of the 5 years:
If the overall portfolio return is positive, they guarantee a return of 100% on your capital investment.  If the overall portfolio return is above 100% you get the actual portfolio return.
If the overall portfolio return is negative then 100% of your capital is protected for a fall of less then 50%.  If the fall is 50% or more then the captial protection does not apply.

One thing, the fund only takes into consideration actual growth on the index.  Any dividends are excluded as that is what is used to pay the guarantees.

There are no recurring fees although there are some initial investment fees of 1.75% of the investment plus taxes.

There are other incentives to boost your initial capital investment if you have some other products with the same company but for the sake of this discussion I'm going to ignore those.

The company offering this investment is well-established and has a very good reputation.  I currently have some retirement investments with them and have not had any concerns with the way they operate.

Would you invest in this - and if not why not?

I'm on the fast track to pay off my house and emotionally don't want to delay that, but this is a limited time offer and logically I think it makes sense to do this. 

Stop me if this sounds like a huge mistake

Your description sounds like a structured note? Nothing wrong with these products as you're basically hedging your exposure to some index; however, you really need to understand these in depth to see how it may (or may not) fit into your portfolio.

Look up "structured notes" or "structured products" and you'll find a lot of information about them. The structure is as simple as you described, "... if index goes up by X, you get Y, if it goes down by W, you get Z..." etc.

[warfreak2]

Agree with Warfreak. A 100% return in 5 years is 14.87% CAGR per year. That's a pretty big assumption they are making

Your expected return is not 100%, that is just one possible outcome which happens with some probability. You can construct ridiculously good and ridiculously bad investments for which one outcome is a 100% return; you can't judge the value of an investment by just looking at one outcome. If you compare S&P500 returns with and without dividends, it turns out their assumption is that they can beat the market in the long run by 2%, not 3.87%. That is a big difference in terms of how much leverage they need to cover their obligations, considering they have to absorb the leverage risk themselves rather than pass it on to their clients.

[pom]

My rule of thumb: if it is complicated, it is usually full of fees (disclosed and/or hidden).

I stay clear of these kind of deals.

[trailrated]

Red flags, keep it simple.

[JohnGalt]

I have an opportunity to invest in a fund that offers some unique guarantees...

...but this is a limited time offer and logically I think it makes sense to do this. 

These two are the red flags for me.  If the product is so good, why is it a high pressure sale?

[libertarian4321]

I have an opportunity to invest in a fund that offers some unique guarantees...

Basically it's a 5 year investment in a fund that invests in S&P 500 and Euro Stoxx 50 indices. At the end of the 5 years:
If the overall portfolio return is positive, they guarantee a return of 100% on your capital investment.  If the overall portfolio return is above 100% you get the actual portfolio return.
If the overall portfolio return is negative then 100% of your capital is protected for a fall of less then 50%.  If the fall is 50% or more then the captial protection does not apply.

Is anyone else's BS meter going off?

This sounds like a scam to me.

[bobmarley9993]

I have an opportunity to invest in a fund that offers some unique guarantees...

Basically it's a 5 year investment in a fund that invests in S&P 500 and Euro Stoxx 50 indices. At the end of the 5 years:
If the overall portfolio return is positive, they guarantee a return of 100% on your capital investment.  If the overall portfolio return is above 100% you get the actual portfolio return.
If the overall portfolio return is negative then 100% of your capital is protected for a fall of less then 50%.  If the fall is 50% or more then the captial protection does not apply.

Is anyone else's BS meter going off?

This sounds like a scam to me.

It's a scam, there is just no scenario where it works out for them.  Just go buy an index fund, don't get involved in this silliness.

[frugledoc]

Sounds to good to be true therefore definitely a scam, just like 99% of the finance industry.

[warfreak2]

It's a scam, there is just no scenario where it works out for them.

There are plenty; they get the dividends, while their promises are contingent on the price growth of the index, not including dividends. They profit mainly when the index is down a little or up a lot - then they pretty much just pay you the price growth and keep the dividends. If the index is down a lot, again they get to keep the dividends. Also they get the 1.75% fee whatever happens. It's actually pretty close to working out for them - see my post above - it isn't as obvious as you think it is, you do have to do some maths to check it.

[bobmarley9993]

warfreak2,

Thinking it through a bit more, I guess they are ahead if the index is down big, or down by a very small margin but it is still a huge gamble for them.  Over 5 years, dividends are maybe 12%, which isn't much.  Just a few scenarios based on that dividend payout:

1 - If the index is down 40%, then the company is out 28% (less the dividends).
2 - If the index is down 20%, the company is out 8%.
3 - The index is up 5%, the company is out 83%.
4 - The index is up 50%, the company is out 38%.
5 - The index is up over 100%, they keep the dividends.

So basically it is profitable if the index is :
 
1 - Down more than 50%.
2 - Down but by less than 12%.
3 - Up greater than 100%.

And in all of these cases the company is only up the dividends of 12%, vs losses of up to 90%.   I am still causing BS on it.

If the overall portfolio return is positive, they guarantee a return of 100% on your capital investment.  If the overall portfolio return is above 100% you get the actual portfolio return.
If the overall portfolio return is negative then 100% of your capital is protected for a fall of less then 50%.  If the fall is 50% or more then the captial protection does not apply.

[Mr Mark]

If they can buy 5 year puts on the index for less than the fees and dividends, they are guaranteed a win.

[warfreak2]

If they can buy 5 year puts on the index for less than the fees and dividends, they are guaranteed a win.

They can't. The investment as described beats the stock market in the long run (by about 2%), you can't use options or derivatives to guarantee beating the market.

[Joel]

Steer clear!

[Tyler]

Your description sounds like a structured note? Nothing wrong with these products as you're basically hedging your exposure to some index; however, you really need to understand these in depth to see how it may (or may not) fit into your portfolio.

Thanks.  You helped me learn something new today.

It's not a scam, but that also doesn't make it a good deal.  Here's a good rundown of the downsides:

http://www.forbes.com/sites/greatspeculations/2012/11/30/structured-notes-buyers-be-warned/

[Mr Mark]

Nice link. I liked the comment that ' there is no free lunch, and even if there was, why would investment bankers share it with you?'

[sol]

By definition, the people offering this product for sale think they will make money off of you.  If they had some system to make money from some source other than your checking account, they wouldn't be asking for money from your checking account.

[Roland of Gilead]

Lehman brothers offered these type of investments.  How did that work out?

[Mr Mark]

By definition, the people offering this product for sale think they will make money off of you.  If they had some system to make money from some source other than your checking account, they wouldn't be asking for money from your checking account.

can we get this emblazoned on the investor alley threshold somehow?

[warfreak2]

By definition, the people offering this product for sale think they will make money off of you.  If they had some system to make money from some source other than your checking account, they wouldn't be asking for money from your checking account.

Surely the same logic applies to Vanguard index funds?

[Mr Mark]

Except that vanguard is a non- profit, dedicated to minimising fees, founded by the person who busted the whole financial industry pig-trough,  Mr. Bogle.

Or indeed, a site called betterment.

[RapmasterD]

Did somebody just say Betterment? Hmmm...I wonder if Betterment makes more sense than Vanguard. Hmmm...

But getting back to this thread, yeah, I'd run fast in the other direction. Roland of Gilead has it down.

[clifp]

My take on this product, is it is basically an Equity-Indexed -Annuity (EIA) without all the insurance features.  But also without all the regulation and oversight of an annuity issued by an insurance company.

You'll gain much of the benefits of this product some downside protection in returned for capped upside by writing covered calls.

[warfreak2]

Except that vanguard is a non- profit, dedicated to minimising fees, founded by the person who busted the whole financial industry pig-trough,  Mr. Bogle.

Never mind that sol's argument doesn't make any reference to the reputation of the company, or its founder, or the company's stated mission. Vanguard aren't the only company selling Vanguard index funds; their ETFs are publicly traded and you can get them through many brokers. But if that still trips you up, Vanguard are hardly the only company selling index funds.

Pretty much any advertised investment fails sol's "if they had some system to make money from some source other than your checking account, they wouldn't be asking for money from your checking account" test. They have investment opportunities, but they require capital, and some companies are in the business of passing on those opportunities for a fee, rather than investing their own capital - either because they don't have the capital, or don't want to accept the risks, or they think founding and running an investment firm is a better use of their capital, because they expect to make above-market returns collecting fees on products that actually do benefit their customers.

You could similarly argue that my electricity provider must be ripping me off, because if electricity wasn't worth less than I'm paying, they wouldn't sell it to me... some trades are beneficial to both parties, otherwise there wouldn't be any trade.

[grantmeaname]

Pretty much any advertised investment fails sol's "if they had some system to make money from some source other than your checking account, they wouldn't be asking for money from your checking account" test. They have investment opportunities, but they require capital, and some companies are in the business of passing on those opportunities for a fee, rather than investing their own capital - either because they don't have the capital, or don't want to accept the risks, or they think founding and running an investment firm is a better use of their capital, because they expect to make above-market returns collecting fees on products that actually do benefit their customers.

I think sol meant "unsophisticated/unsuspecting retail investors", not "all owners of capital".

[Mutton Chop]

No.

[Blindsquirrel]

 Hell no would I do that. Would Mr Bogle, Mr. Buffet, Soros, etc buy such an investment vs SPY or VTSTX? I think not.

[mikaty]

Thanks for all the comments and advice.

I think I will try and find a simpler way to invest my money.

One thing that I did not specifically mention (because I wanted your views on the investment itself) is that as a South African it can be rather complex and expensive to invest in US/European markets due to exchange controls and taxes.

Of course I can invest in the local stock market for cheaper but the nature of my job can make that a bit of a hassle.  Basically I work in IT for a corporate/investement bank and there can be quite a bit of red tape.  I will research the exact requirements etc and see what options I have in this regard.

[pom]

You may want to ask the investment professionals how they invest their own money.

As a former big-4 employee, I also had quite a bit of restrictions. Investing in a straight index fund made it easy to prove that I was not trading on inside information.