Real vs Superficial Investment

Before we go into detail on what I mean by Real and Superficial Investments? I would like to pose a question. Are you keen in investing and belief in concept of money growth through investments? If your answer is NO, my next question is, Was it because of a bad experience you have personally encountered or heard from your love ones. What exactly is investment?

Investment is the choice by individual to risk his savings with the hope of gain. Rather than store the good produced, or its money equivalent, the investor chooses to use that good either to create a durable consumer or producer good, or to lend the original saved good to another in exchange for either interest or a share of the profits.

In simple layman's term, It is risking something for more things. Investment can come in many forms. In business, investment would be like putting money in a product which you predict will give you better return as its demand rose and value appreciates in future. In short, how well the product sells is an indication of how much your money will grow in terms of returns. In finance, the concept is the same, however instead of a product, you are putting your money on companies. How well the company does is indication on how much your money will grow in returns as well.

If you see closely, these two are actually linked. By investing money in the financial market, for example, stocks and shares, you are putting your risk on the performance of the company. And that risk is also affected by the product the company produces or sells. So, indirectly, you are putting your money in the product. This is what Warren Buffet meant by knowing the company first before you put your money in.

So what am I getting at here? How is this linked to Real vs Superficial Investment?

Each of us have the desire to be rich. I mean lets face it, who desires to be otherwise right. When an opportunity is presented before us in the form of unbelievable returns, most will grab it without thinking much about it. True, we are told not to miss out on opportunities. However so, we are also told not to be reckless.

Example

Suppose an advertisement is placed that promises extraordinary returns on an investment – for example, 20% on a 30-day contract. The objective is to deceive laypeople who have no in-depth knowledge of finance or financial jargon. Verbal constructions that sound impressive but are essentially meaningless will be used to dazzle investors: terms such as "hedge futures trading", "high-yield investment programs", "offshore investment" might be used. The promoter will then proceed to sell investors--who are essentially victims of a confidence trick--stakes, by taking advantage of a lack of investor knowledge or competence.

Without the benefit of precedent or objective prior information about the investment, only a few investors are tempted, usually for smaller sums. Thirty days later, the investor receives the original capital plus the 70% return. At this point, the investor will have less incentive to put in additional money and, as word begins to spread, other investors grab the "opportunity" to participate, leading to a cascade effect deriving from the promise of extraordinary returns. However, the "return" to the initial investors is being bought out of the investments of new entrants, and not out of profits.

This my friends, is what you might call, the Ponzi scheme.

One reason that the scheme initially works so well is that early investors – those who actually got paid the large returns – commonly reinvest their money in the scheme (it does, after all, pay out much better than any alternative investment). Thus those running the scheme do not actually have to pay out very much (net) – they simply have to send statements to investors showing them how much they earned by keeping the money, in order to maintain the deception that the scheme is a fund with high returns.

Promoters also try to minimize withdrawals by offering new plans to investors, often where money is frozen for a longer period of time, in exchange for higher returns. The promoter sees new cash flows as investors are told they could not transfer money from the first plan to the second. If a few investors do wish to withdraw their money in accordance with the terms allowed, the requests are usually promptly processed, which gives the illusion to all other investors that the fund is solvent.

The catch is that at some point one of three things will happen:

1. The promoters will vanish, taking all the remaining investment money (minus the payouts to investors) with them;
2. the scheme will collapse under its own weight, as investment slows and the promoters start having problems paying out the promised returns (the higher the returns, the greater the chance of the Ponzi scheme collapsing). Such liquidity crises often trigger panics, as more people start asking for their money, similar to a bank run;
3. the scheme is exposed because the promoter fails to validate their claims when asked to do so by legal authorities.

What is NOT a Ponzi scheme

• A multilevel pyramid scheme is a form of fraud similar in some ways to a Ponzi scheme, relying as it does on a disbelief in financial reality, including the hope of an extremely high rate of return. However, several characteristics distinguish these schemes from Ponzi schemes:
  • In a Ponzi scheme, the schemer acts as a "hub" for the victims, interacting with all of them directly. In a multilevel scheme, those who recruit additional participants benefit directly (in fact, failure to recruit typically means no investment return).
  • A Ponzi scheme claims to rely on some esoteric investment approach, insider connections, etc., and often attracts well-to-do investors; multilevel schemes explicitly claim that new money will be the source of payout for the initial inenturevestments.
  • A multilevel scheme is bound to collapse a lot faster, due to the necessity of exponential increases in participants to sustain it. By contrast, Ponzi schemes can survive simply by persuading most existing participants to "reinvest" their money, with a relatively small number of new participants.

• A bubble. A bubble relies on suspension of disbelief and an expectation of large profits, but it is not the same as a Ponzi scheme. A bubble involves ever-rising (and unsustainable) prices in an open market (be that shares of a stock, housing prices, the price of tulip bulbs, or anything else). As long as buyers are willing to pay ever-increasing prices, sellers can get out with a profit. And there doesn't need to be a schemer behind a bubble. (In fact, a bubble can arise without any fraud at all - for example, housing prices in a local market that rise sharply but eventually drop sharply because of overbuilding.) Bubbles are often said to be based on the "greater fool" theory. Although, according to the Austrian Business Cycle Theory, bubbles are caused by expanding the money supply beyond what genuine capital investment supports, and in this case would qualify as a Ponzi scheme, with expanded credit taking the place of an expanded pool of investors.

• Although non-fraudulent in intent, a pension fund can share some of the characteristics of a Ponzi scheme in that, except during the final period of the fund's life-span, the outgoing cash used in any month to pay pensions is usually taken from the incoming contributions of the active members of the pension scheme. In a year of poor equity returns such as 2008, a pension fund can often perform worse for its members than a Ponzi scheme.

• Robbing Peter to pay Paul. When debts are due and the money to pay them is lacking, whether because of bad luck or deliberate theft, debtors often make their payments by borrowing or stealing from other investors they have. It does not follow that this is a Ponzi scheme, because from the basic facts set out there is no indication that the lenders were promised unrealistically high rates of return via claims of unusual financial investments. Nor (from these basic facts) is there any indication that the borrower (banker) is progressively increasing the amount of borrowing ("investing") to cover payments to initial investors (as, again, Ponzi was not the first to do).

• Mult-ilevel marketing

If you are planning to invest your hard earned money, do take into consideration of a few factors

• Time horizon - The period of investment. Investments need time to mature. A safe time horizon will be 5 years or more. There is no fix rule, however, statistically, 5 years will be able to generate good returns depending on the risk profile. There fore make sure that within that time spent, you have no use for the invested money.
  

• Risk Profile - This is crucial to determine the type of fund that is suitable for you. Financial advisers need to run through a few questions to determine your risk appetite. The process might seem pointless since you might believe that you already know what you want. However, believe me, it is to your advantage.

• Fact finding - Do make sure that the advisor run through a few questions. This is essential to see your financial capacity and stability. Sometimes we are so eager to do something that we tend to overlook certain factors. The advisor will go into detail to see the capacity and feasibility of the amount of your investment.

Reference = Wikipedia