The question I was asked most in nearly a decade of writing about stupid investments was what someone needed to do to be a smart investor.
I can answer that question for average investors in three sentences, totaling just eight words:
Know yourself. Understand what you’re buying. Be careful.
The second-most asked question is much tougher, because it is about the telltale signs and warnings that most commonly signal a stupid investment.
Examine every investment with an eye toward the following:
High costs. The harder it is to make money after you pay the freight, the more likely you’ve got a poor investment choice. That’s not to say some mutual funds, insurance policies and other securities can’t overcome costs, but most don’t. Even when an investment has beaten the odds and delivered despite high costs, a buyer should be asking if that can continue, because expenses almost always come home to roost. Moreover, costs often times are hidden or buried in complex investment products. Investors need to recognize one way or another – whether it is out in the open or buried in the details – you’re the one paying the costs, and no one would be selling it to you if they couldn’t make something on the deal.
Bad timing. This is not so much about engaging in market timing as it is being aware of where an investment really is at the moment you buy it. Studies show that investors typically bail out if an investment declines more than 20 percent from their buying point; even if a stock takes off from there, all the investor experiences is the loss.
Too often, investors look at the positives without recognizing the factors that could delay the success they foresee. For example, investors might love the concept behind a popular business, but may not recognize that short-sellers are swarming the stock, a condition that average investors typically would want to avoid, or they look at a stock that has fallen into bargain territory without considering what might drive the price down further before it can rebound.
Mass-market appeal. It’s not that appealing to a wide audience is bad; it’s that it may be much easier to get a better deal by putting just a little bit of effort into it. For example, most insurance policies that you see pitched on television — the ones that promise coverage with no questions asked — are priced as if the buyer already has one foot in the grave. If you are otherwise uninsurable, that might be okay, but the vast majority of people buying these policies could get more coverage, pay lower premiums or both simply be not jumping in with the crowd. While there are times to run with the herd, it’s important not to follow along with them mindlessly.
Misdirection, shouted-down questions or dissent, or problems swept under the rug. If you ask enough questions and the responses are hinky, nervous, worried or hyper-aggressive, there’s trouble. If everything doesn’t add up in your head, you deserve answers to your specific questions.
A never-give-up sales pitch. American Business Financial Services continued to send invitations to invest every few weeks, right up until the firm filed for bankruptcy protection and suspended sales and redemptions for investors. Likewise, if you request information on the Gerber Grow-Up Plan or the AARP Guaranteed Acceptance Life Insurance plan, you may be in for mailers until your loved ones are collecting on your life insurance.
Poor governance and questionable investment premises. Sometimes, an investment stinks just because of how it is constructed, the style of management or the ethics of executives. It may be a great marketing idea that’s a poor investment concept.
These flaws aren’t always evident at surface level, but when uncovered can quickly turn an investment that looks good into an ugly situation.Chuck Jaffe is senior columnist for MarketWatch. Reach him at cjaffe@marketwatch or P.O. Box 70, Cohasset, MA 02025-0070.