12/20/2012 7:00 PM ET|
How to spot a dodgy investment
It's generally buyer beware in the world of investing. These not-always-obvious warning signs may alert you to danger.
In my decade of writing about stupid investments, I’ve often been asked this question by readers: “How do I become a smart investor?”
I can answer that question for average investors in three sentences, totaling just eight words: Know yourself. Understand what you’re buying. Be careful.
If you follow those instructions, it’s hard to make big investment mistakes.
The second most common question is tougher to answer, because it concerns what a stupid investment looks like and how to spot one. There’s something of an art to this. Two years ago at a big industry conference, when I told a friend I was hunting for column fodder, he asked how I would find it. I told him I would wander until I smelled it and stop when I stepped in it.
Today, I want to leave you with an enhanced sense of smell.
Since early in 2003, my Stupid Investment of the Week column has examined the conditions and characteristics that lead average investors to choices that are less than ideal. Since no one sets out to make poor decisions and buy something lousy, the idea here typically was to deconstruct the case for purchasing an investment and highlighting its potential for going wrong.
Bad investments -- and the problems that lead to them -- aren’t going anywhere. The investments I’ve examined over the past decade have ranged from good companies that, for a time, were bad stocks to inherently, irrevocably flawed investment products -- and seemingly everything in between. While more than 20% of the investments I've covered are gone now, some live on, and probably will forever, kind of like investment cockroaches, always there to feed on investors who are sloppy in their financial housekeeping. And for every stupid investment that disappeared, at least one new concept or issue has stepped in to fill the void.
While not every bad investment idea comes with a screaming red flag, some characteristics routinely arise that should indicate you’re headed into the danger zone:
The harder it is to make money after you pay the freight, the more likely you’ve got a poor investment choice. That’s not to say some mutual funds, insurance policies and other securities can’t overcome costs. But most don’t, especially over long periods of time.
Investors must recognize that there is no free lunch; one way or another, you’ll pay the costs -- whether they are out in the open or buried in complex details -- and no one would sell that investment to you if he couldn’t make something on the deal.
It’s not that appealing to a wide audience is bad, but it doesn’t necessarily lead to great investment products, and consumers often can get a better deal just by putting a little individual effort into it.
For example, most insurance policies pitched on television -- the ones that promise coverage with no questions asked -- are priced as if the buyer already has one foot in the grave. If you are otherwise uninsurable, that might be OK, but the vast majority of people buying these policies could get more coverage, pay lower premiums or both simply by not jumping in with the crowd.
While there are times to run with the herd, it’s important not to follow along mindlessly.
If you want to know whether you are being sold the equivalent of financial swampland, be sure to ask about dry basements or resale value.
If the answer -- whether from the sellers or the people already in the neighborhood -- comes back, “Look at the lovely kitchen,” or, “Only someone with a loser’s attitude would ask that,” run away.
If you ask enough questions and the responses are hinky, nervous, worried or hyperaggressive, you’ve got trouble. If everything doesn’t add up, keep asking. You deserve answers.
When the people supporting an investment aren’t giving you straight talk, they’re hiding something. No matter what it is, you’re not going to like it.
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