From coffee drinking to bonkers (My take on networking activities)

Economics adage “there is no free lunch” is being refuted in the Philippines with the introduction of the soaring price of premium coffee shops. These premium coffee shops provide posh seats occupied by students, mobile workers and prominently ‘networkers’. Let me be clear at this stage that I do not say that networking is bad or wrong, and let it be clear that networking in this context pertains to marketing system whereby products are being sold via personal acquaintance. Products again in this context can be physical product or financial product aiming to provide out-of-market rate of returns.

Networking of goods is what most of are familiar with and made famous by Herbalife which primarily generates revenue from its networking activity. This is not to single out Herbalife as there are many other networking of goods specially in the pharmaceutical business which generate revenue through laddered profit padding. While this business practice have been in constant scrutiny in the United States, it is still proliferating across the Philippines, though there are still no legal basis to declare such as illegal.

The networking of goods is not all that interesting as it is usually very limited in scope and rests on the fact that it is dependent on the ladder subordinate being able to sell-off the goods and repurchase goods from you. This in essence is a buy-and-sell system which most often will not result to any significant fraudulent outcome or losses. At the close of day, this is not expected to result to any significant losses since tangible goods are easily transferrable for a price and another stupid will still buy the product and you’ll be able to recover what you’ve bought. This should end the discussion for physical product based networking activity. A tip on this is to stay focussed on reliable brands that you’re dealing with then hopefully you’re in good hands.

What is fearsome from my perspective is the trading of financial product through networking activities. My attention was caught some months ago when a friend came to me asking for advice on a piece of financial product which generates 30% interest per quarter, again I stress, PER QUARTER. Simple interest calculation will tell you that 30% per quarter translates to 120% return per annum and compounded interest calculation would translate to a staggering 185.61% return per annum.

I have inserted the table below as a reference on how I came up with the annual rate of return that I indicated above. The information below shows how “financial experts” from these fraudulent schemes will show you how your earnings can double or triple over a short period of time.

A briefing to those without background on anything finance related is that simple interest assumes that you take home your interest and retain your investment at 100k per quarter. On the other hand, compound interest assumes that whatever monies generated through the scheme will be reinvested into the scheme, that’s why the formula assumes that the initial 30k interest earned will be reinvested and so on. So by the end of year, assuming that you’ll be withdrawing your money out of the scheme, you would have earned 120k in interest if you’re not reinvesting or you would have a take home pot of 185.6k in interests if you are a wise investor willing to reinvest in the generous scheme.

This is good money, really. Bank interests in the Philippines usually play at around 0.25% per annum (meaning, your 100k will earn you 250 pesos, not 250k) and corporate bonds will not pay you an interest higher than 10.0% (assuming clean bonds) plus you have to pay a final withholding tax on those interests. How enticing it really is to earn quick money at such a generous rate.

If it was only true, I would have gone and invest a lump sum to receive interest annuities equal to what I’m earning as an accounting advisor or even as an auditor. If only such interest rates were true, banks, corporations and government should cease to issue bonds and equity or purchase equity and bond investments that will not even earn a 185.61% rate of return in one year and continually compounding. Bottom-line, it’s not true. And definitely, it’s not sustainable.

The point of the above illustration is not for you to run-off now and join a scheme that provides such a generous rate of return. The above illustration is meant to educate the readers how interests can be so enticing that you’ll fall into the trap of a “financial expert” offering that sort of return. Allow me to be painful and continue my illustration as to how these schemes fall. If you’ve already invested a significant sum, I would dearly recommend not to completely pull-off, but hold-on till I end my discourse where I would indicate my recommendations.

There are two common ways that this sort of scheme will end:

· Perpetrator is satisfied with his cash on hand and slacks off; and

· Perpetrator is a greedy shit and ends up without sufficient cash to cover maturing “investments”.

The key differentiator between the two is simple. Greed and excess greed. The first perpetrator is greedy but he knows the limitation of greed, he plays with the “investors” until his target cash on hand is met and looses the grip then disappears. The second perpetrator is a greedy shit, I have to use a less violent curse on the perpetrator as I am trying to be a kinder person, that does not know the limitation of greed and holds on until the scheme is so large that cash on hand is not sufficient to “lap” on maturing settlements.

The concept above is vague for a lot of people without the necessary financial background, or as they say, common sense is no longer really that common. So let me put it into a hypothetical scenario:

Let’s assume that perpetrator have zero cash at the beginning of the year, that is January 1, and he came up with a wise idea of initiating a “Money Flourishing Scheme” (MFS) whereby investors earn 30.0% per quarter (same as above example). He tries to talk through Stupid 1 and being stupid, Stupid 1 invested a lump sum 100k investment in the MFS on January 1. So as at January 1, perpetrator got free cash of 100k but will need to repay 130k by March 31. By the end of January, the perpetrator was able to catch Stupid 2 to invest in another 100k into the great MFS. Now, payment time comes and Stupid 1, being stupid enough, decided to reinvest the whole 130k for another 3-month roll hoping to receive 169k by end of June 30, perfect for his initial condo down-payment due by the end of June.

The scheme continues with Stupid 2 being paid 130k by the end of the 3-month period, but alas, Stupid 2 became aware of the potential fraud and stopped to invest. Now, the cumulative cash of the perpetrator as at April 30 is left at 70k and settlement of Stupid 1’s investment of 169k would not be possible (as highlighted in yellow). Now there are multitudes of ways for the perpetrator to settle this issue:

1. Walk away now with 70k in pocket and leave Stupid 1 to rot in stupidity;

2. Find another stupid to invest in at least the deficit of 99k;

3. Pray that Stupid 1 will continue to roll his 169k (which will not happen because Stupid 1 will use the money to pay for his condo down-payment);

4. Incentivise Stupid 1 or 2 to find another stupid to invest in the scheme (i.e. through a higher interest rate or through a one-off incentive called as a referral bonus);

5. Dunno, am not fraudulent enough to think of any other escape routes.

The above scenario is a highly simplistic portrayal of how this sort of scheme works in real life, but to consider factors such as the expensive lifestyle of the perpetrator and the usual “coffee” or “car show” expenses that the perpetrator will need to prove his capacity to pay, that’s a highly complex issue to consider.

Hopefully the above scenario-based discussion provided a clear understanding of how cash lapping is working at this sort of scheme. Looking at the above scenario, it highlights the necessity for these schemes to continually grow in the number of “investors”, which I dubbed as “stupids” for clarity sakes, to ensure that sufficient cash is available to “lap” on maturing payments. As we understand, this schemes are bound to fall given the fact the joiners of these type of schemes can reach a saturation point and monies will just circle around members of the scheme until such time that the scheme will crash.

Now a question arose as I ponder on the above issues: Is it indeed stupid to invest in such schemes? There is no clear answer and it will all depend on your risk appetite. As a commoner and an ignorant person, not stupid excuse me, I arrived at the following general recommendations:

· Learn more about the scheme and investigate as to the facts and circumstances surrounding the scheme;

· Know how much you’re willing to lose and invest in the amount that you’re willing to lose;

· Don’t be too greedy and reinvest up to the point that you can lose;

· In the above scenario, after year 1, start to invest in only the 120k or the 186k that you’ve earned from the scheme, that’s all losable monies;

· Consult and stop being stupid, stop listening to financial advisors or experts that you do not personally know;

· Demand for proof of investment and ensure that you have enforceable right to redeem your investment; and

· Stop drinking coffee with strangers and don’t open your mind so much.