How to Not Get Scammed When Investing

 

There are a lot of investment options out there.  To the go-getter investor, there is nothing stopping him from accumulating gains and building his wealth.   More investment opportunities exist today than ever before.  Stocks, bonds, put options, call options, exchange traded funds, reverse ETFs, mutual funds and hedge funds of all shapes and sizes are there for the choosing.  All those options for investing combined with the low interest rate climate and relatively easy credit creates the perfect environment to invest and build wealth.  The financial instruments available to investors these days make it possible for one to make money even if the stock market crashes.  The key, however is to choose the right investment out of all the thousands to choose from.

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Another risk that arises from such a dynamic marketplace is the risk of getting scammed.  Cheated, conned, fooled, ripped off.  Yes, the free market is a wonderful place to do business in.  Only you can limit your potential. But it’s also rife with competition, self-interest, conflicts of interest, greed, false claims and deception. Investing is not just about knowing where to put your money, it’s also about protecting it.

So how do you NOT get scammed in the free market?  Here are a few things you should consider.

  1. When an investment seems too good to be true, it probably is. At best, there’s a catch that remains undisclosed to you. To every investment there is a best case and a worst case scenario.  Usually, those who want your money will highlight the best case and keep quiet about the worst possible case that can happen for you.  It’s your job as an investor to understand about the worst case.  Make sure you research and ask around before diving into an investment opportunity.   If your stock broker was one hundred percent sure about that stock, he wouldn’t recommend that you buy itanymore.  He would be shutting his mouth and be the one buying all of it instead.

 

Take the case of junk bonds.  These unsecured corporate loans offer an unusually high rate of return.  An investor might be attracted to the returns but he also has to consider the risk of default.  Usually, higher returns entail a higher risk to the investor.  And as we have seen in the past few months, a number of funds invested in junk bonds like Third Avenue have defaulted on their obligations to investors.

 

  1. Beware of the Ponzi scheme. There was Bernie Madoff and even more recently, Martin Shkreli.  The Ponzi or pyramid scheme is a form of market fraud where an institution pays unusually high returns to its investors but sources those funds from other investors rather than from its operating or trading gains.  In a pyramid scheme, usually the ones who invest at the early stages have the best chances of getting paid.  But as more and more people join the pyramid scheme, the market gets saturated and the last ones to join get paid nothing.  Assuming a pyramid scheme can go on undetected until every human on earth has joined, it will still eventually collapse once the pyramid runs out of new investors to fund payouts to old investors.  It’s an unsustainable system and that’s why it’s illegal.

 

  1. Know the methods of market manipulation. Some people who have enough shares to move the demand and supply of a certain investment may also have the ability to move the price to their benefit – and to your detriment.  When you sense price or volume movement that seems contrived – stay out.

 

For example, in an Initial Public Offering (IPO), an underwriter can squeeze the float so that there is just a limited supply of the issue offered.  He would do that so he can sell his IPO allocation at a higher aftermarket price.  Conversely, someone who holds a lot of a certain stock may start dumping his shares to create a panic and then buy back everything at a much lower price than he sold it for.

 

A research analyst may issue a BUY recommendation long after his institution has accumulated the stock.  The analyst issues the glowing report,encouraging you to buy so that his institution can sell whatever they accumulated at a gain.  After they sell everything, the analyst might issue a SELL recommendation so they can buy back.  So on and so forth.

 

Now underwriters or analysts don’t generally do such things.  But you should not discount the existence of risk and conflicts of interest in the marketplace.These are all examples of how a market manipulator can benefit at your expense.By just being aware of the worst that can happen, you can improve your chances of avoiding it.

By knowing and avoiding these pitfalls, you can make more intelligent investment decisions.  You can eliminate the bad deals from the start.  You can then focus on the real, legitimate investment opportunities that work. Start by finding the good and the honest and from there, you can discover the real gems –  the brilliant, the revolutionary, the long-lasting investments that will set you up on your way to wealth.