Today’s tale is a cautionary one. It’s also personal and true. It will be laced with lessons, painful ones. I think it will help provide some insight into why I champion individual investors taking control of their own money, commiserate with those that have been burned by investments, and am saddened when traders lose money with a good system due to improper implementation.

Sometimes you meet investors who seem to do no wrong. Their history is profit-laced and void of any major missteps. Somehow they’ve curried favor with Lady Luck and her smile shines upon them from sunup till sundown. I’m not one of those investors. Unfortunately. I’ve had more than my fair share (whatever that is) of bumps and bruises along the way. One such episode was a well-intentioned investment I made which got wrapped up in a Ponzi scheme and separated me from some $20,000 smackers.

The year was 2009. I was newly married with a pocket full of cash. The stock market was in the throes of the biggest, baddest bear market seen since the Great Depression. I traded it like hot garbage due to my inexperience and was thus desirous to diversify into other asset classes.

A friend of mine introduced me to a company that was in the auto lending business. They provided the capital for a car dealership so they could offer to finance customers buying vehicles. In addition to the auto lending, this company also owned a variety of real estate properties which they purchased with investor money. The returns for investors were paid out with the rental income and interest paid from the auto loans. Furthermore, the returns (all 10.5% per annum) were paid out monthly which provided a consistent income stream.

It was a legitimate business with a decade long track record of paying out to investors EVERY SINGLE MONTH. The risk on the auto lending side was one of liquidity. That means I may not have been able to get my money out for a while if I needed it. In theory there isn’t much principal risk (that is, the risk of losing your investment) with auto lending, as the automobiles could be repossessed and resold if the buyer defaulted on their loan.

My funds were meant to be provided for the auto lending side of the business.

Sounds good, right? That’s what I thought too.

At first all was well. Each month I received a little less than a 1% return on my invested capital sent straight to my mailbox. Picking up dividend checks in the mailbox is the best. But then a few months in, the trouble started. The economic downturn of 2008 was finally coming home to roost in the real estate and to a lesser extent the automobile markets. So what would a smart business owner do here?

First, tell investors on the real estate side that the markets suck. And, well, that 10.5% return isn’t viable anymore. To keep the whole machine running we have to cut your returns down something more like 2%.

Second, if that’s not doable then, well, we stop paying out returns altogether and perhaps liquidate a few properties (at, admittedly, terrible prices) to raise sufficient capital to return investors’ monies when their notes come due. Hopefully, most investors stick it out and when the market recovers we can return to cutting their monthly checks.

Third, worst case we sell all properties at, maybe, 70 cents on the dollar and return investors monies. They lose anywhere from 20% to 30% of their capital less whatever dividend payments they received along the way. It’s a bummer, to be sure, but not near as bad as getting blown to smithereens and losing 80% to 100% of your capital, right?

I would have done something similar on the automobile side. Cut dividend payments, repo cars, etc… to weather the storm.

Is that what the kingpin in charge of this company did? No. He was an idiot. And I’ll tell you exactly why … next time! I’ll also include the primary lessons you can extract from this tale to help you become a better trader.

Financial freedom is a journey

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