Five warning signs an investment is too good to be true
You can’t invest without a bit of risk.
But weighing the level of risk isn’t always easy. While it partially depends on your appetite for thrill, it also depends on adequate research and consideration before buying an investment, as well as trusting your gut – and the person selling the investment to you.
Investment fraud isn’t uncommon, and while it’s not always easy to spot, there are also some telltale warning signs that may indicate if an investment is too good to be true.
Keep an eye out for these investment red flags.
Be wary if your broker works on commission – according to John Csiszar of GOBankingRates, they’re not obligated to prioritise a client’s needs and wants. Since some investments pay more commission than others, a broker might be more inclined to push for an investment that costs more.
Also take note of any marketing tactics they may try to employ and play the sceptic. A broker’s job is to sell – if they try to amp up the excitement, describe an investment as “the next big thing,” promise to make you rich, or act like they have “inside information” (which is illegal), it may be wise to back away, according Todd R. Tresidder, blogger behind the Financial Mentor who made himself a millionaire within 12 years through successfully investing.
Brokers may also try to put a timeline on an investment, saying it’s a “hot” stock. The goal is to pressure you to buy now before the “deal” is gone. According to Tresidder, investments that are good today are still good tomorrow. There shouldn’t be a limited time to “get in.”
“If you feel that an unscrupulous broker or financial planner has misled you, then you may have to contact that person’s branch or complex manager to lodge a formal, written complaint,” investment adviser Justin J. Kumar advises in a Kiplinger article.
A rightful salesperson should never encourage you to use your life savings for one investment, Tresidder said.
“No legitimate investment salesperson should ever fail to clarify your past investment experience and risk tolerance before recommending an investment,” he wrote. “A con man may skip this essential step in the sales process.”
They also shouldn’t ask you to provide false information on your application, ask for your bank account number, or encourage you to borrow money, especially from a retirement account, to invest, he added.
“Some sophisticated investors use margin – or borrowing – to leverage the effects of their investment,” according to Csiszar, who added that if you borrowing money incurs higher risk and interest on the margin loan. “However, this is best left for high-risk traders.”
Liquidity is the ease at which you can turn an investment back into cash. For example, stocks and bonds are liquid because they can be converted into cash quickly, but larger assets such as property can take a while to transfer into cash. There’s more at stake if you can’t get your money out of an investment when you want.
“Delays when withdrawing money may point to illegitimacy,” wrote Tresidder. “Only fixed-term securities such as CDs, hedge funds with periodic redemption rights, certain partnership interests, and other liquidity constraints agreed to in writing prior to investing should limit your ability to access your cash when it comes time to exit.”
Beware if you’re being encouraged to “‘roll over’ promised payments with higher investment returns” – it’s a classic Ponzi scheme trick, according to Kumar.
Investing shouldn’t be complicated. Investment strategies explained with terminology overkill and sophisticated investments marketed to smaller investors with a $US100,000 maximum initial investment are worth being wary of according to Tresidder. He also said unsophisticated investors can be vulnerable to investment fraud because “they rarely perform due diligence.”
“Never buy into the idea that you are too old, young, or financially inexperienced to understand an investment,” Tresidder said. “If you don’t understand it, then don’t invest in it.”
Generally speaking, investments with higher returns are riskier. Kumar warns against “guaranteed” investment opportunities – trends typically fluctuate, so an investment that continuously has positive returns may be too good to be true.
“Never trust anyone who promises a high return in a short period of time,” wrote Tresidder. “Above market return is the number one characteristic of investment fraud. It’s the bait designed to hook you.”
He added that low risk, no risk, or a guarantee is the second sign of investment fraud. “The truth is, every investment strategy has an Achilles Heel, making ‘no risk’ incongruent with reality. The more you are guaranteed, the more you should examine what you are being guaranteed against.”
The opposite is also true – according to Csiszar, low stock prices can continue to drop and remain there for a long time. He advises using that time to research the stock and make a wise buying decision.
Another red flag is if the stock performance is better than the company performance.
“A stock that goes straight up in value while its earnings remain flat or down could be headed for a fall,” wrote Csiszar. “Typically, earnings drive stock prices, so a stock price that goes up while company earnings lag behind makes for a dangerous cocktail.”
Just remember: If an investment sounds too good to be true, it probably is.