Investment Warning Signs and Red Flags
It’s true that every investment involves some degree of risk. But it’s still wise to minimize that risk whenever you can.To spot the difference between an appropriate level of risk and an inappropriate investment, watch for these warning signs and red flags.
Be wary of the way investment opportunities are presented. Too often, legitimate products like living wills, trusts, or financial and retirement planning services are pedaled in high-pressure seminars. Sure, these seminars tout "free" advice and perks like complimentary lunch or dinner. But that free meal comes with a side of high-pressure sales pitches on "limited-time opportunities."
If you opt to attend these types of seminars—either out of genuine curiosity or the chance for a free meal—decide ahead of time that you won’t buy anything while you’re there. If the educator is truly interested in your business, the opportunities should be available after the seminar, too.
Never disclose any personal or financial information, like your Social Security Number or bank account balances, even in the name of more personalized, free advice.
If you’re interested in whatever financial products or investment they’re selling, give yourself a few days to think about the decision. Better yet, get a referral from someone you trust and confirm the opportunity with a different broker or adviser.
Investment products aren’t one-size-fits all. If you haven’t heard of an investment because it’s less common, that’s a red flag to proceed with caution. It doesn’t mean the investments are bad, per se. They’re just not a fit for the average investor.
- OTC stocks: Over-the-counter or OTC stocks are securities that are not listed on a major stock market exchange, like the New York Stock Exchange (NYSE) or Nasdaq Stock Market. Instead, these are traded via a broker-dealer network, usually because the stocks are from smaller companies that don’t meet the requirements for listing on a formal exchange.
Some OTC stocks report to the Securities and Exchange Commission (SEC), a regulating body for these activities. Others may not file reports to any regulating body. It isn’t illegal, but this lack of information is the biggest risk of OTC stocks and makes them more vulnerable to investment fraud.
- Penny stocks: Like the name implies, penny stocks are a specific kind of OTC stock that sell for less than $5 a share. The low price makes it easy to purchase many shares at a rock-bottom price, with hopes the price will grow.
Some penny stocks trade on the NYSE or Nasdaq, but most do not. Even though penny stocks are a popular way to see fast returns with a minimal investment, many are a bad trade-off with high volatility and no return. For the average investor, it’s best to steer clear of highly speculative penny stocks.
You can’t avoid investment fees entirely, but it’s a best practice to review and minimize charges whenever possible. For instance, it’s common for annual fees to cover management expenses and sales charges to compensate sellers. There may also be fees if you sell or withdraw during a restricted period.
It’s smart to scrutinize every investment fee you’re billed for and try to find ways to minimize little charges that can make a big impact on your wealth over the long term. Studies suggest that investments with higher fees frequently underperform compared to investments with lower associated fees.
Common Investment Fees
- Brokerage fees: This can include annual fees, inactivity fees, research and data subscription fees, trading platform fees, paper statement fees, and account closing or transfer fees. Avoid most of these fees by choosing the right broker for your investment needs and style.
- Stock trading fees: Charged when you buy or sell stocks. There could also include commissions or fees for buying and selling investments like options or exchange-traded funds.
- Mutual fund transaction fee: A type of brokerage fee that is charged when you buy or sell mutual funds.
- Expense ratio: A percentage of your investment in your fund that is charged as an annual fee by mutual funds, index funds, and exchange-traded funds.
- Sales load: A commission or sales fee on some mutual funds, paid to the broker or salesperson who sold the fund.
- Management or advisory fee: When you’re charged a percentage of assets under management.
- 401(k) fee: An administrative fee related to the costs to maintain the plan.
Every broker website should detail broker fees. Make sure to clarify details before signing up.
Liquidity refers to how easily an investment is converted to cash. Investments with low liquidity are harder to sell on a timeline that works for you. This can include certain stocks, but also investments like those set up through a real estate limited partnership.
In these partnerships, investors pool their money to invest in real estate. They aren’t publicly traded, so if you want your money out of the arrangement, you’ll need to find someone to buy your portion of the partnership at a price you want. It’s a tall order that could prove difficult, and depending on the partnership, not permitted. So tread carefully.
Unlike traditional certificates of deposits that span anywhere from 3 months to 5 years, callable certificates of deposits typically don’t mature for as long as 10 to 30 years. Early withdrawal of funds often comes with fees, just like regular CDs.
However, for callable CDs the penalties are typically steep. Also, financial institutions can opt to "call away" or redeem CDs before they’ve matured. This means you lose out on possible returns and the higher interest rate promised. Callable CDs should be FDIC-insured; make sure you receive written verification of this fact.
Highly volatile investments like futures contracts and options contracts require close monitoring to avoid potential losses. Even if you do watch them closely, there is always the potential for massive losses.
New investors should steer clear of these products.
There is always another "expert" on the internet with can’t-miss investment advice. Take everything you read on the internet with a grain of salt, even in online investment chat rooms or newspaper ads.
If you receive unsolicited calls, emails, or letters with "exciting investment opportunities," don’t take the bait. Especially if these offers include promises of guaranteed returns or no-risk investments. (Again: every investment involves risk.)
Some scammers buy mailing lists from specific magazines to target vulnerable audiences. Other con artists hock investments in public places where they target specific demographics. Never discuss your financial situation with a stranger—even a helpful one.
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