Investment Keywords To Watch Out For
What prompted the writing of this post was a radio commercial I heard the other morning while commuting to work. It was from some real estate firm that promised to teach me how to buy, hold, and sell properties with no money down and no risk. Imagine that: no risk! How could anyone turn down such an offer?
It is often difficult to exercise the proper due diligence necessary to make good investment decisions. It can be easier, however, to avoid making bad ones by watching out for certain red flag keywords that may indicate the need for additional scrutiny. As a public service I will share a few of those keywords here.
It is a basic tenet of investing that the higher the return you are expecting to get, the more risk you must be willing to accept. Imagine two investments, one returning 5% with no risk (i.e. guaranteed) and another returning 5% with a 20% chance that you could receive less. Who would ever buy the latter? The market would force the second investment provider to increase the return to compensate a buyer for taking on the additional risk. This holds true for any type of investment (real estate, stocks, gold, CDs, even works of art). The one exception are U.S. treasury bills, notes, and bonds, which are backed by the full faith & credit of the U.S. government and as such are considered risk free (at least for now). If you encounter the words “no risk” as part of a pitch or recommendation for an investment, it’s a lie (to be blunt). Would you really consider investing in something that starts out with a false claim?
A variant of “no risk” is “no market risk.” This is commonly used by an investment offer that does not involve the capital markets, such as real estate or accounts receivables. Although it’s likely true, if the investment promotion focuses on the market risk that you will be avoiding without addressing all the non-market risk that you will be incurring, at best it’s misleading. Once again I’d recommend adding it to your waste basket collection.
This is another variant of “no risk.” Have you ever known anything in life that’s guaranteed? Even investing in U.S. treasury bonds won’t guarantee you a certain return unless you hold them until maturity. If you run across this word in some investment opportunity, you might ask the promoter on what or on whom the guarantee is based. Better still, just ignore it.
I see this word most commonly from smaller investment firms offering mutual funds or investment management services that are directly or indirectly promising either to get you higher returns or protect you from some amount of losses. Inevitably their approach involves a claim of superior market timing or investment selection that is based on a “proprietary” methodology. It may in fact be proprietary, but that doesn’t mean it works. If the promoter can’t (or won’t) explain the methodology to you in a way that you can understand it, the investment really is nothing more than a gamble.
A variant of “proprietary,” this word is so ubiquitous that I though it deserves its own paragraph. “Learn Warren Buffet’s secret for successful investing!” Putting aside the nonsensical implication that there are investment secrets known only to a small handful of ultra-rich individuals, consider the logic of the claim. If the “secret” is being promoted via public media, how could it possibly remain a secret? And once it’s out, wouldn’t it lose all benefit since everyone would now be doing it? Besides, just because Warren Buffett makes money doing it – assuming in the first place the secret is the way he actually invests – doesn’t mean you will.
This is nothing more than using past history to justify and promote future returns. Just because an investment did well over the last ten years tells us nothing about what it will do over the next ten. Read any of Nassim Taleb’s books (e.g. Fooled by Randomness) and you’ll get an understanding of how luck and randomness plays a much greater part in investing success than most people would admit.
There are numerous words in investment promotions that represent red flags to me. Hopefully these few I’ve shared will help you with your investment decision-making.