Bernard "Bernie" Madoff was a legendary figure on Wall Street and former chairman of Nasdaq who ran the largest Ponzi scheme in history. Michael de Guzman was a chief geologist at Canadian mining firm Bre-X Minerals who claimed to have found gold in the Indonesian jungle. When we look at entire industries, there have been and continue to be examples, such as cryptocurrency, that are rife with scams. With so many con artists and scammers out there trying to take your hard-earned money, how can you steer clear of them? This post will present four suggested questions that you can incorporate into your decision-making process when reviewing investments, helping you develop the habits and systems necessary for informed financial growth.
Plans are worthless, but planning is everything. — Dwight D. Eisenhower
What is my exit plan if everything goes south?
Obviously the goal of any investment is to make a profit. Allocating capital somewhere can be considered a move of optimism: You like the investment and want to see it succeed. Yet, I don't believe many investors put a lot of thought into the other side of the equation: What if things don't go well? A wise investor should have a comprehensive plan that includes both an entry and an exit strategy.
You see it all the time in the financial markets: A negative event occurs, panic ensues, and a selloff happens, causing a significant drop in value. I firmly believe people panic because they don't have a plan for how to handle adverse events.
Examples of a good plan include determining your holding period, employing stop-losses if necessary, and listing any other triggers for exiting an investment.
How easy is it to withdraw your money?
Banks offer bonuses to entice you to open an account with them. Brokerages facilitate money transfers and allow you to buy stocks with a few clicks. Annuities promise a guaranteed return over the long-term. Businesses make it easy to deposit your money with them. How easy is it to get your money back out?
Before making a deposit, find out what provisions there are to return your capital. Can you initiate a transfer any time? Is there some catch that involves you needing to give advanced notice? Is there a lock-in period, which is common for investments like certificates of deposit?
What do those offering an investment have to gain?
Get into the habit of questioning the motives of those who either directly sell or promote investments. For example, YouTube videos may have clickbait titles such as, "In X number of days, it falls apart", or "This is the date when the economy will crash". Look in the video description and don't be surprised if you find affiliate links to products such as gold. Those who stand to profit from gold often use scare tactics to draw you in and encourage you to buy what they're selling.
Another example is workers in the financial industry who profit off of commissions. Financial advisors who are compensated with a percentage cut or similar structure may have a conflict of interest. They may try to sell you on investing in something that nets them a higher commission rather than what is genuinely best for you. Fee-only advisors are a better option because you pay them a set amount and that helps with getting objective advice.
What red flags may be present?
The forms and tactics scammers utilize can be seemingly endless. Get into the habit of watching out for red flags and educating yourself on what those are. Here is a small selection of red flags to illustrate:
- Promises of guaranteed returns. Any investment carries risk, so when someone offers you a no- or low-risk investment, watch out.
- Be cautious of high-pressure sales tactics. Urgency is a method used to get people to make a decision before they're ready and properly informed.
- The old adage 'too good to be true' is a good principle to keep in mind. If your gut tells you something smells fishy, it may very well be a scam.
There are plenty more red flags to consider, such as lack of transparency, shady history, affinity fraud (targeting specific communities), and more.
Conclusion
These questions provide a framework, along with actionable advice, for assessing risk and recovery when evaluating investments. This is by no means an exhaustive list, nor the only considerations to keep in mind. Always remain vigilant and continue to educate yourself to protect your financial well-being.