[as a post-script to yesterday’s post on Leveraged Investing, please read Canadian Capitalist’s thoughts on the same issue]

I once remember an investment counsel friend of mine who met a potential client with a high net worth who wasn’t happy with her current investment advisor. When he asked her what she expected him to provide by way of return on investment on her stock portfolio she said 15%-20% with no risk. My friend has common sense and his common sense told him that this was not going to be a happy relationship. Rather than lose the rest of his hair, he walked away.

I am reminded of this story lately as we tackle potential returns on investment in the financing company (for those new to the post, please see here for a back-ground). For those lawyers out there, we are not guaranteeing any returns on investment to our investors but, on a structural level, we have to consider what type of investment we are: conservative, moderate or aggressive since this goes hand in hand to who are ideal investors are. However, what I am beginning to find is that the market-place is full of unrealistic expectations. Perhaps this is due to the fact that the stock market has generated historically high returns for the last several years. Perhaps the Internet has trained us to have 4 second attention spans and to conveniently forget last year much less the dot com bust (or even Enron). Perhaps we all collectively think that this time it really will be different and the good times are here forever.

Regardless of the reason, by observation only, I have found that many people now consider 15% plus to be an “acceptable” rate of return. While achievable, a company that attempts to return 15% ROI to investors year over year exposes its investors to a variable of risk that, if you thought about it for a second, is too risky for most average investors. Companies that are supposed to return 15% plus are supposed to have venture capitalists as investors who could lose their money and not worry about it too much. We worked on some financial models and to consistently achieve 15% plus year over year the financial company would have to invest almost 100 cents on the dollar in riskier plays and hope that the market conditions stayed the same. Oh, we also wouldn’t get paid either. We would be constructing a potential deck of cards hoping that the economic winds didn’t blow us over. Being a big supporter of how banks manage their risk, we have set aside a reserve of money which we will not invest and taken a prudent approach on how the money will be invested. We hope that this will produce a steady rate of return over time rather than promise big, peak early and have the house of cards come down on us.

Cheap money since 9/11 has conditioned us to turn a blind or partially obscured eye towards risk. As I mentioned yesterday, there are some who support leveraged investing without educating people on downside risk; I suspect if this was 1982 the voices for leveraging people’s homes to invest in the stock market would not be so great. I watch mutual fund managers stock-pile cash and I begin to get nervous. I’ll update you on how our prudent approach works.