An old scam has returned; higher-yielding deposits (apparently at no risk) courtesy of finance companies targeted predominantly at retirees suffering from severe rate cuts from mainstream banks. Not only have several retiree clients written about the rise in unsolicited offers to them, but I was greeted with a range of junk mail with promises of “high returns” during my recent visit to Sri Lanka. Higher-yields come at higher risk, and investors, whether senior by age or not need to clearly understand these risks before they commit funds. Free lunches do not exist in this industry.
At the most basic level, finance companies on-lend your money to less credit worthy borrowers as personal funds or to acquire motor vehicles or capital equipment purchases. This works fine as long as delinquent loans are manageable, which is no different to what a bank may do with your funds. But that’s where the similarity ends. Lately many finance companies are dabbling in the stock and property market for high returns. Such activity implies that any invested capital is being taken up the risk spectrum. In effect, they reward you with fixed returns, but use those funds for high and undiversified risks. If you want to take equity risk, it’s much better to do so yourself, with assets firmly in your control as opposed to opaque financiers over whom you have no control.
The attraction of higher-yields is an understandable narrative. The Central Bank is determined to cut benchmark cash rates to low levels in order to rein in the interest payment on government debt, in so doing reducing bank funding costs (via cheaper deposits) in the hope that they will on-lend to stimulate the economy. They have the political freedom to do so as elections are five years away for savers to vex their anger at the ballot box. At least in theory then, interest rates shall remain low well into the foreseeable future. Theory of course will be knocked off its patch should food and energy inflation remain unchecked; both beyond the control of the Central Bank. The high price of basic goods and services are driving many seniors towards taking the high-yield gamble. While official figures put inflation at around 7%, real life inflation affecting the life of senior citizens may be as high as 12% according to the Seniors Index of the Investment Advisory Group (IAG), the only independent financial life planning specialists in Sri Lanka, with extensive experience in individual retirement income and lifestyle planning. On those figures, most investors in fixed deposits at major banks may be losing anything from 4-8% in purchasing power alone.
The chase for yield also stems from financial illiteracy of the general public. According to calculations by IAG, anyone wanting to retire at age 65 who has inadequate savings will need 14 times their annual earnings as a lump-sum, to generate 60% of their final salary to live on till they pass away (with life expectancy set at 80). This drops dramatically to only 2 times annual earnings when aged 35. The bottom line is that retirement planning and savings should start early, although the calls on the purse of a young family may be significant. It also provides the basis for seeking professional, independent financial advice from an early stage. The lack of savings cannot be substituted by high risk, high-yield strategies post-retirement.
Elderly investors are natural targets in part because they may be more susceptible to fraud. A 2008 study by researchers at the Georgia Institute of Technology found that older adults are significantly worse than younger people at detecting whether someone who may have stolen money is telling the truth.
What's more, according to research by Harvard University economist David Laibson and his colleagues, the typical person's ability to make astute financial decisions peaks at about age 53, then wanes with each passing year; another study found that investing ability takes a steep drop after age 70.
Brian Knutson, a neuroscientist at Stanford University, has monitored the brain activity of dozens of older investors. "When they encounter a risk," says Prof. Knutson, "they will be more likely than younger people to focus on the upside of that risk." That can lead older investors to play down the downside.
According to Mara Mather, a psychologist at the University of California, Santa Cruz, older adults also seek less data than younger people do when making complex decisions—and will go out of their way to avoid negative information or confrontations. This "high avoidance," Prof. Mather says, can lead older investors to get sucked further into a scam, throwing good money after bad.
It is important for older investors to run financial decisions past a younger relative or someone who can resist the emotional pull of the situation. At the very least, older investors should never attend financial marketing events unless they are accompnied by a trusted younger friend or family member. And younger relatives should periodically ask their older family members whether they have been pitched any products or services by financial companies.
After all, the return of your capital is as important, if not more, than any return on your capital.
(Kajanga is an Investment Specialist based in Sydney, Australia. You can write to him at email@example.com).