ASK QUESTIONS BEFORE INVESTING
8/19/13
Banks and Brokerage firms are frequently fined hundreds of millions of dollars for selling bad investments, misrepresenting investments to their clients or leaving out critical information needed for clients to make an informed decision. The problem is that these firms are making so much money they just look at these huge fines as a cost of doing business. This is because the business of selling investments very profitable. So in light of this bad behavior many people wonder, can the average investor really get a fair shake on Wall Street?
The small investor can win - but you have to know how the game is played. When you play a game and you don't know the rules but the other side does, how often are you going to win?
Rule #1 Trust, but verify. If you just trust someone you are taking a big chance. You have to realize that most investments are sold - not bought. When people have money to invest they call an "advisor". It may be someone they know and trust, someone they go to church with or a friend of a friend. That person whoever they are most likely calls themselves a "financial advisor". No matter what they call themselves they are usually a broker or an insurance agent and they are going to sell you something because that is their job.
Rule # 2 Know what you will be paying for the advice you get. Everyone is guaranteed to make money - except you. Even if your "financial advisor" is your best friend understand that they will make a lot of money from doing business with you. And most likely they will be selling you a product that they will continue to make money on for the life of the investment. They may also get extra compensation and kickbacks or travel and vacations for selling you their firm's "recommended" or "preferred" mutual funds and other products.
Not only will your "advisor" make money - the firm they work for or represent will make money too. On top of that the managers of the investment you buy will make money. So, you typically have three layers of people who get paid and they get paid year in and year out whether you make money or not. And don't look for all of these fees on your statement. Most of the fees are taken out before you get your statement. This is why most of the time you end up buying high cost (to you) products like annuities and mutual funds. Recently, many "advisors" have also added very expensive fee-based accounts to their high cost products list.
Rule #3 Don't just buy what sounds good. It is easy to buy (or to get sold) a popular investment. But it may not be the best investment for you. Think back to 2007 and 2008. The economy was crumbling, banks and brokerage firms were failing and you would only buy safe secure investments. You would never buy anything that had to do with the stock market so advisors were selling "safe" investments like bond funds and gold funds hand over fist. Unfortunately, many of those "safe" investments have cratered while the stock market has doubled.
Another example of an easy sell are the technology stocks you bought about 10 years ago when they were hot. Technology type investments were all over the media so they were easy for you to buy or for "advisors" to sell you. It was like shooting fish in a barrel. But these stocks turned out to be overvalued and many of them lost huge amounts of money. What happens in the long run when you buy popular investments is that you end up with a portfolio full of mediocre at best, has-been investments.
Rule #4 Know the risk you are taking. Every investment involves some kind of risk. Yet the possible downside of investments is glossed over and rarely discussed at length. There is usually a blanket statement like "your investment can lose money" and you sign all sorts of papers that say you understand all of the risks, even though you really don't. You need to understand what specifically can go wrong with an investment and how much it would affect you.
Rule #5 Understand what you are buying. If you can't explain the investment you are buying don't buy it. If you don't understand investing or finance you just have to trust someone and that makes it an easy decision for you. As long as the investment "sounds good" you go along with it and hope it does well.
There are people out there who spend more time buying a microwave than they do investing $100,000. You must take the time to really understand what you are buying. If you don't have any questions about the product you are buying or don't know what questions to ask you are in trouble. If you don't want to bother to take the time to find out what is going on you shouldn't be surprised or angry about any bad results.
Bill Oldfather offers fee-only money management and personal financial advice. Oldfather Financial Services, LLC is located at 2033 Central Avenue in Kearney Nebraska. Email tobill@oldfatherfinancial.com