Life is beautiful. You just turn 55 and you are finally able to say “bye bye boss!”. You have accumulated enough money to trade your office for a golf cart and your pen for a Callaway X Driver (that’s my dream anyway!). You thought you would have to work until the age of 60 but that cool guy from that mutual fund company you met at a “informative retirement meeting” told you about a revolutionary product.
This amazing product is a well balanced mutual fund giving you 5%, 6%, or 7% guaranteed in your pocket year after year! Is it because they were able to clone Buffet brains? (Actually Validea Capital is trying to do so). Do they found the last GIC on earth giving a 7% yield? Or are they simply not telling you the whole story? GOT IT!
I recently met a client with this “wonderful product” in his portfolio. He told me how the “financial analyst” who presented the product answered all his questions and that everything seems pretty good. In a world where the stock market is diving faster than Michael Phelps during the Olympics, who would ignore such investment proposition?
So the guy invested 50K in early 2006. He never made a single withdrawal (the 7% return was deposited in his cash account which he used to buy more shares of the same fund). So technically, his investment should worth 59K (50K*7%/12month*32 months). However his investment portfolio was showing 55K! Where the other 4K disappeared? What happen? Where is that 7% return Guaranteed?
The 7% return is actually a fixed amount of $3,500 (7% of 50k) that the client did receive in his cash account. When the fund is not making 7%, where to do you think they found the money to send the client 3,5K? A Donation? Return on Capital (ROC) !
Imagine, you are receiving 7% return and you are not even fully taxed on it! For someone who doesn’t understand ROC, this sounds like a perfect world. Unfortunately, there is no free lunch in finance. The poor guy was getting his capital back to buy more shares of a fund not making the promised return.
The idea itself is not bad, but you must be aware that you might touch your capital and that the nice graph showing 8% returns might not happen. I know, life sucks and financial advisors are part of life 😉 Fortunately, you have The Financial Blogger to help you out seeing those things before they happen to you!
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