Avoiding Scams - and Other Don'ts

09/05/2002 12:00 am EST

Focus:

Steven Halpern

Editor, thestockadvisors.com

"Experience is simply the name we give our mistakes," said Oscar Wilde.  And there is no more important factor in investing than learning from one's mistakes.  The ability to analyze and understand investment errors is critical in becoming a successful investor. Indeed, the overriding goal at InterShow is to help educate investors. But what NOT to do can be as important as advice on what to do. Here are some top advisors' most important Don'ts:

 

Few advisors are as focused on educating and protecting investors as Doug Fabian, editor of The Maverick Advisor. Here’s his advice on scam-proofing your portfolio:

 

"Money funds aren't the only way to protect your portfolio during a bear. You need to be cautious of investment scams preying on those trying to recoup losses and/or looking for alternatives in today's low-yield environment. Three of the most popular now (according to the NASAA):

 

1. SECURITIES SOLD BY UNLICENSED INDEPENDENT INSURANCE AGENTS. Promissory notes, limited partnerships, and charitable gift annuities are the most common vehicles offered by scammers who recruit insurance agents to push their bogus investments. The agent gets a big commission; you get fleeced.

 

2. VIATRICAL OR SENIOR SETTLEMENTS. Though not all fraudulent, interest in the life benefits of terminally ill patients or aging adults is nothing more than pure speculation.

 

3. OIL AND GAS SCHEMES. The rise in natural resources prices means more chances to lose your shirt on worthless deals.

 

Even seemingly safe investments can have hidden risks. Brokered or callable CDs sold by brokerage firms could tie your money up for 20 years (returning far less than your original investment if you need to redeem early) and may not be FDIC-covered. And credit downgrades and increasing junk issues make corporate bonds/bond funds extremely risky in today's scandal-plagued environment.

 

Your best defense? Education. First, ask questions to get the facts. Is the salesperson licensed to sell securities? Is the investment registered? Why is the promised return higher than current trends? What's the worst-case scenario? Then check regulatory Web sites such as: http://www.nasaa.org and http://www.nasdr.com. If you still don't  understand how the investment works or how the salesperson/company is paid, walk away."

 

Tom Gartner, in the Motley Fool Stock Advisor, offers this list of investment don’ts:

 

"Thousands - probably millions - of investors have been hurt badly by bad decisions over the last few years. And, unfortunately, there are still more mistakes to be made.  These four, I believe, are the most dangerous. So I urge you to consider these words before you make any new investing decision:

 

1. DON'T let fear - or greed - destroy you financially. Take some time to look at the history of the market. You'll see euphoric highs followed by devastating plunges. You'll see depressing lows followed by spectacular gains. And in nearly every case, you will win out by buying when others are scared of the stock market...and selling when others start to get greedy.

 

2. DON'T assume all companies or executive teams in an industry are "the same."  Back in 1999, investors erred by throwing money at low-quality technology companies as if they were the next Microsofts. Now, investors are tarring all stocks, because a few CEOs are crooks. Do your homework - don't paint with a broad brush. Learn to distinguish the excellent from the dreadful, the forthright from the fraudulent.

 

3. DON'T ignore your mistakes. I fell into that trap, myself, a few years back. I figured that as long as I owned a few great companies like Johnson & Johnson (JNJ) or Microsoft (MSFT), they'd cover up all the other mistakes I'd make. Well, a) I've since learned that only a handful of companies have the staying power of JNJ or MSFT - they're very rare; and b) when mistakes start costing 60%-90% of your investment, you need a bunch of monster winners to erase those deficits. Be smart. Learn to value your companies and cut them loose when they let you down.

 

4. DON'T trust corporate earnings. As we've seen - a hundred-times over - they can be, and are, manipulated every-which-way to show stellar performance. Usually quite legally - that's how arcane accounting laws are. But luckily, it only takes five minutes to do your own initial assessment of a company's health. The key? Free cash flow from operations and the growth in that number.

 

5. DON’T let greed and fear take turns running your financial life. They'll derail your dreams again and again. Right now - as is customary near market bottoms like that in 1974 and this one today - fear starts winning out. But don't let fear paralyze you. Yes, there are plenty of stocks you should NOT own today. But there are also great companies at great prices that we will find together. You'll kick yourself for not saving and investing for your future today in this environment."

 

"Don’t follow the rules that apply to a typical bear market," says Tobin Smith, editor of ChangeWave Investing. "For instance, look at what happened to the investors who stayed with the the market always rises after Fed rate cuts rulebook. Or how about those who followed the, the market always rises six months in advance of the end of a recession rule. The rules of run-of-the-mill bear market investing have nothing to do with the monster post-asset bubble bear markets like 1929-33 and 1974-75. Investors and advisors ignorant of these fundamental rules of post-bubble bear markets continue to be convinced they are right and the market are wrong.

 

There are three rules of post-bubble bear markets: first, cash is king.  Second, post-bubble bears are always meaner and mightier than most everyone can imagine. Third, those with the most buying power during the final inning of excessive pessimism make a fortune on the inevitable bull market that follows."

 

"Don’t give up on the stock market," says Richard Band.  "But make sure you’re investing prudently. Conduct a portfolio checkup.

 

1) Are you properly balanced between stocks and fixed income? Our model portfolio, designed for a typical investor in his or her late 50s, calls for 75% in stocks (or equity mutual funds) and 25% in various kinds of interest bearing paper. There is nothing wrong with a higher percentage in stocks, if you’re young enough (or wealthy enough) to accept the risk. But if you’re more than 75% in stocks, you should give serious thought to lowering this percentage or hedging this exposure. 

 

2) Are your stock positions adequately diversified? My rule is to not put more than 5% of your wealth in any single stock. Enron, WorldCom, and Tyco showed how vital this policy is. Equally important, you want to diversify among many industries. Just think of the folks who were ruined by overexposure to technology. Finally, for even greater safety and stability, don’t overlook high-dividend stocks. Companies with strong and rising dividends tend to resist stock market decline – and bounce back to even loftier share prices as the years roll buy. Even if you don’t think of yourself as the classic income investor, high-dividend stocks can do you a big favor.

 

If you’re violating either the balance or the diversification rules, use market rallies as an opportunity to discard your weakest holdings. Every time the stock market rallies, I comb thorough my holdings, asking myself, 'Do I still want to own this?'  Personally, I reassess my own portfolio anytime the Dow jumps 10% or more for its low of the past three months. If your portfolio is bloated with losers, put it on a diet. Thin out the investments likely to lag the market over the long pull. It’s time to give your portfolio a thorough checkup."

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