Impossible Promises: What Returns Cannot Be Guaranteed
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In short
A guarantee is not the removal of risk. It is the transfer of risk to a named counterparty.
Scope, and a correction this article has to make before it can be useful. The common warning that nothing in investing is ever guaranteed is false, and its falsity is dangerous. Guarantees exist, they are contractual, and a reader who has been told otherwise will discount the entire warning the moment they encounter a real one.
So this article says which guarantees are genuine, identifies the one claim that cannot be true, and explains why. The signs are characteristics of the mechanism, and their absence is not evidence of legitimacy. No firm, product or issuer is named. Figures use the Pillar 22 risk-free rate of 4.0% and are illustrative teaching values.
Which means the useful question is never whether something is guaranteed. It is: guaranteed by whom, and what happens if that party fails.
Guarantees that are real
| Arrangement | Who is guaranteeing | What remains |
|---|---|---|
| Government debt held to maturity | An issuer with taxing power | Inflation risk, and the issuer's own credit standing |
| Insured deposits | A protection scheme, up to a stated limit | Anything above the limit; inflation |
| Insurance and annuity contracts | The insurer | The insurer's solvency over the life of the contract |
| Capital-protected structured products | The issuing bank | A credit exposure to that bank, plus whatever return was given up for the protection |
Each of these is a genuine contractual promise, and in each case the promise has a promisor who could fail. The protection in the last row is the clearest illustration: a capital guarantee from a bank is not an absence of risk but a swap of market risk for bank credit risk, and a reader who does not see it that way has misread the product rather than been deceived by it.
The claim that cannot be true
A return materially above the risk-free rate, guaranteed, with no corresponding risk.
The reason is not that such returns are rare. It is that the offer contradicts itself. If a party could reliably produce a guaranteed return above the risk-free rate, that party could borrow at the risk-free rate and keep the difference, without limit and without soliciting anyone.
| Quoted as | Annual equivalent, compounded | Spread over 4.0% | Riskless profit on $1,000,000 borrowed |
|---|---|---|---|
| 1% per month | 12.68% | 8.68 points | $86,825 a year |
| 2% per month | 26.82% | 22.82 points | $228,242 a year |
| 1% per week | 67.77% | 63.77 points | $637,689 a year |
| 0.5% per trading day | 251.44% | 247.44 points | $2,474,371 a year |
Worked example: the offer describes someone declining free money. A guaranteed 2% a month is 26.82% a year compounded, which is 22.82 percentage points above the risk-free rate. Anyone able to deliver that could borrow a million at 4.0% and retain $228,242 annually with no risk taken, repeating the trade at whatever scale credit allowed. So the offer asks a reader to believe that a party in possession of an unlimited riskless profit machine would prefer to give the profit to strangers. That is the contradiction, and it does not depend on any judgement about markets. Note also what these rates do to time: at 1% a week money doubles every 1.34 years and at 2% a month every 2.92 years, against 17.7 years at the risk-free rate. Figures are illustrative and describe no actual offer.
Why the quoting period is itself a characteristic
Returns in these offers are very often quoted per day, per week or per month rather than per year.
The reason is mechanical: the annual figure would be self-refuting, and the short period conceals it. One per cent a week sounds modest. Sixty-eight per cent a year does not, and they are the same claim.
So the conversion is the single most useful arithmetic a reader can perform, and it requires nothing but compounding. A rate quoted in an unusually short unit is a rate whose annual equivalent the offeror would rather not state.
The trilemma
High return, guaranteed, and available on demand. Any two of those can be had. All three cannot.
Guaranteed and liquid is a deposit, and the return is low. Guaranteed and high-yielding would be the contradiction above. High-yielding and liquid exists, and is not guaranteed, which is the ordinary condition of the assets described across this group.
An offer presenting all three at once has not solved a problem that the rest of finance failed to solve. It has described something that does not exist.
Worked example
Where the language does the work. The terms guaranteed, risk-free, principal protected, capital preserved and fixed return all have legitimate uses, and in legitimate use they are accompanied by the identity of the guarantor. The characteristic worth noticing is not the word. It is the word appearing without a named promisor, or with a promisor that turns out to be the same entity taking the money. A guarantee given by the party who would have to be solvent for the guarantee to pay is not a guarantee. It is a restatement of the offer. Which is the same structural point as Fraudulent Platforms makes about registration badges: evidence produced by the party being assessed is not evidence.
Restating the caveat, and one further limit specific to this article. An offer can be fraudulent while promising nothing implausible at all. A modest, believable, well-hedged-sounding return is entirely compatible with there being no underlying activity, and the structures in How Investment Fraud Works do not require an extravagant promise to function. So the arithmetic on this page identifies a claim that cannot be true. It does not identify the claims that merely are not true, and those are the more common case. The absence of an impossible promise is not evidence of legitimacy.
Frequently asked
8 questions
Is it true that nothing is ever guaranteed?
No, and repeating it is harmful. Guarantees exist and are contractual. A reader told otherwise will discount the whole warning the moment they meet a real one.
What is a guarantee, then?
Not the removal of risk but the transfer of risk to a named counterparty. So the useful question is never whether something is guaranteed, but guaranteed by whom, and what happens if that party fails.
Which guarantees are genuine?
Government debt held to maturity, guaranteed by an issuer with taxing power and still exposed to inflation; insured deposits, guaranteed by a protection scheme up to a limit; insurance and annuity contracts, guaranteed by the insurer subject to its solvency; and capital-protected structured products, guaranteed by the issuing bank.
What is the catch with a capital guarantee from a bank?
It is not an absence of risk but a swap of market risk for bank credit risk, plus whatever return was given up to obtain the protection. A reader who does not see it that way has misread the product rather than been deceived by it.
What claim cannot be true?
A return materially above the risk-free rate, guaranteed, with no corresponding risk. Anyone able to deliver that could borrow at the risk-free rate and keep the difference without limit, so the offer asks you to believe a party with an unlimited riskless profit machine would rather give the profit to strangers.
What do those rates actually annualise to?
At a 4.0% risk-free rate: 1% a month is 12.68% a year, 2% a month is 26.82%, 1% a week is 67.77% and 0.5% a trading day is 251.44%. On a million borrowed at 4.0%, the 2% monthly claim implies $228,242 of riskless annual profit.
Why are returns quoted weekly or monthly?
Because the annual figure would be self-refuting and the short period conceals it. One per cent a week sounds modest, sixty-eight per cent a year does not, and they are the same claim. A rate quoted in an unusually short unit is one whose annual equivalent the offeror would rather not state.
Does an ordinary-sounding return mean an offer is safe?
No, and this is the more common case. An offer can be fraudulent while promising nothing implausible at all, because the structures described elsewhere in this pillar do not require an extravagant promise to function. The absence of an impossible promise is not evidence of legitimacy.
References
- Investor.gov (SEC) — Investor Alert on promises of guaranteed or high returns —
- Investor.gov (SEC) — Structured Notes with Principal Protection (the issuer credit exposure) —
- FINRA — Structured Notes: what "principal protected" does and does not mean —
Educational and informational only — not investment advice, a recommendation, or an offer to buy or sell any security. Investing involves risk, including the possible loss of principal. Worked examples use fictional companies and figures.