Understanding Investment Risks and How to Spot Scams

All legitimate financial investments carry some level of risk. Investing, in many respects, is like gambling. When you walk into a casino with $500 for an evening’s entertainment at the blackjack tables your goal may be to walk out later that night with a higher amount, but you may leave with empty pockets. Investing is similar, but there are ways to limit your risks and to avoid scam investments that promise overnight riches. Anyone that promises you will make money and not lose any money on your investment is lying and/or running a scam. No investment can guarantee you a percentage return.

Whether you place money into a savings account, purchase stocks and bonds or invest in mutual funds and other entities, you hope for the reward of increasing your investments, deposit or purchase. The risk and the financial literacy lesson to any investing is that you may lose a portion or even all of your investment. In general, the higher the potential reward, the greater the risk.

Historically, stocks are considered a high-risk investment but provide an annual return over the long-term of about 10%. Investing in bonds involves less risk but also a lower annual return of about 6% over time. Treasury bonds usually provide a slightly lower return, while short-term Treasury bills and savings accounts are the safest investments but generally offer returns of 3% or less.

Lets recap some of the basic financial literacy skills of investing. When you buy stock you are essentially purchasing a part of a company. When you buy a bond, you are, in effect, loaning money to a company. Bad business decisions, political changes and events over which a company has no control, such as the coronavirus, can affect your investment. In the event of a business bankruptcy, bondholders will be paid before stockholders which is one reason bonds are a less-risky investment.

Losing money on a legitimate investment does not mean you were conned into making a bad deal. A loss may mean you made poor choices, put too much money into one type of investment or that the market was impacted by events over which you had no control. However, one thing you can control is avoiding being conned into putting money into a scam investment.

How to Spot Scam Investment Schemes

Successful investing typically requires vigilance and patience as well as taking on risk. Tactics used to defraud investors are becoming sophisticated and increasingly effective. Some people have lost hundreds of thousands of dollars to con artists by falling for get-rich-quick schemes or unrealistic promises. When considering an investment, there are certain warning signs of which to be aware.

Financial fraudsters succeed by appealing to greed. Promises of a guaranteed return on your investment, an incredible profit from a small expenditure or that losing your initial investment is impossible should all be met with skepticism. These are promises that cannot legitimately be made. Every honest investment carries a risk that you may lose money.

No one can promise you a certain percentage return on your investment. For example, if you are promised a 8% annual return on some real estate investment, stock, or something else, that is definitely a scam. No one is ever promised anything with any investment. Heck, even if someone guarantees a low rate of return, say a couple percent a year, that too is a fraud. The only guaranteed investment is an FDIC insured savings account.

Recognize pyramid schemes that involve promising you great returns simply by bringing in more people to the program. This is the scam that Bernie Madoff as well as many others have run. Some scams offer incentives to bring in your friends, relatives and co-workers. However, most legitimate investment programs do not offer commissions or other rewards for referrals. Similarly, avoid Ponzi schemes in which scammers guarantee you will quickly become wealthy by investing in a promising business or other investment that does not actually exist.

A sales pitch to invest now or lose out on a big deal is a red flag. Be wary of “limited-time” offers or ones offering a special discount for a specific number of investors who “act now.” Con artists like to move fast, get your money and vanish. Never be rushed into investing.

Similarly, avoid deals that require you to pay an advance fee. A typical con involves a scammer offering to buy your low-value stock for a high price on the condition you pay an advance fee. After you pay the fee the scammer disappears and you never get the promised money.

Don’t be conned by claims that “everyone” is getting in on a great deal. If a sales pitch relies more on convincing you that lots of people are taking advantage of a fabulous deal rather than focusing on why the investment makes sound financial sense, hang on to your checkbook.

Be cautious of sellers who offer something for free. Scammers will give potential investors a gift to make them feel guilty and increase pressure to buy into their pitch. As financial literacy teaches, “nothing in life is free” when it comes to investing. Getting something for free does not mean you should feel obligated to sink your money into an investment you have not taken adequate time to research.

No investment can guarantee you won’t lose money. As noted, every single investment (whether stocks, bonds, annuities, real estate, etc.) has risk. If a company or individual guarantees you will not lose any of your principal on an investment, then that is a lie.

Understanding these red flags of investment fraud and common tactics used by con artists will help to protect you from making bad decisions and suffering serious financial harm.

How to Prevent Becoming the Victim of an Investment Scam

There are numerous common-sense financial literacy steps you can take to help ensure you are safely investing your hard-earned money. Some of the suggested actions are below.

Take the time to investigate any potential investment. Don’t act on impulse or simply accept testimonials from strangers or those claiming to be “satisfied customers.” Be sure you fully understand the investment you are about to make. Ask the seller or company as many questions as needed to feel comfortable. A good rule is to invest in what you know. Don’t get involved in a complicated investment scheme you don’t understand.

Research the individual or investment opportunity. There are free ways using government databases as well as those from regulators to see if a broker has been disqualified or arrested in the past. Research investment advisers using FINRA. There is also the SEC.gov as well as state regulators.

While this may be more challenging or more sophisticated, it is recommended to check out a company including its owners, directors and managers. Ask a trusted friend for assistance or spend a small amount to get the advice of a veteran CPA or attorney who can look into the background of the company or seller offering the investment. The federal Securities and Exchange Commission and your state’s securities regulator should also be able to provide relevant information.

Limit your investing activity to established, well-known brokers and companies like Schwab, Fidelity, Vanguard and others. Stick with traditional investments that are heavily regulated like stocks, bonds and treasury notes. Avoid “alternative” investments which often have limited oversight such as buying into a small business, hedge fund, crypto or real estate partnership. Regardless of the type of investment, get everything related to it in writing.

Avoid investing with anyone who promises an “inside” deal or who claims to have exclusive information about the potential investment. Not only may the proposed investment be a con, but it may also involve you in committing a crime. Exercise caution with sellers offering no-risk investments or money-back guarantees.

Investing can be confusing, and get free advice on managing money, budgeting, attend workshops and other financial literacy help from non-profit credit counselors. They offer face to face advice as well as online resources, telephone support, and so much more. Find programs offered by non-profit credit counselors.

Be wary of any unsolicited e-mail or text offering low-priced stocks and other investments. As with any unsolicited e-mail, do not click on a link. These messages may not only be scams, but they may also be designed to infect your computer with malware. If you did not ask a legitimate broker to contact you, do not respond to the message.

Know there is risk to any investment

In summary, act slowly, do your research using a variety of sources and never let greed be your guide. Always remember no one or company can guarantee you won’t lose money. No company or salesman or woman can promise to make you money, or promise a certain return on your investment. Be wary of scams when it comes to financial literacy.

Investors who actively monitor their investments and have the patience to allow the market to work for the long-term will generally reap valuable rewards while minimizing potential risk along the way. Just invest, knowing that there are risks to any investment and if some one tells you otherwise, it may be a scam.

By Jon McNamara