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| Dec 20, 2005 4:28 pm |
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How To Recognize And Avoid Risky Investments |
Steven Boaze
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The patterns of any particular investment will
detail the relative risks and rewards undertaken
with each investment. Risks can be defined as
"the chance or possibility of injury, damage or
loss." Risk focuses on the future and our ability
to forecast that future. In turn, the ability to
predict the future is largely dependent on what
you've learned from the past. The best you can do
is to study the record and draw on experience -
your own and that of others.
On the surface, the relationship between risk and
return seems straight forward. In general, you
will find that risk and return move in the same
direction. In other words, if you accept a higher
risk, it is possible to achieve higher returns.
High-risk investments invariably promise a high
return.
But equally important, where it is possible to
win big, you can lose big. And the odds are
always with the "house" (the provider of the
risk-return). If all it took to create instant
wealth was assuming high risks, then you could
assure yourself of millionaire status simply by
attending the race track every day and betting
all your money on the long shots!
Avoiding Risky Investments
No other advice on investing is complete without
a few important warnings. The investment industry
has its share of unscrupulous people who, at
best, will mismanage your investment, and at
worst, steal you blind.
They'll come at you with Ponzi schemes, pyramid
deals, real estate that's never been any good and
never will, and telephone offers or email offers
of stock or funds or oil leases or gems or
precious metals, etc., that offer large and easy
returns with no risk.
These salespeople play on a universal desire to
"get something for nothing" and to "get rich
quick." Most of us are not immune to a good
pitch. However, by just taking the simple
precaution of thoroughly investigating an
investment offer yourself or through a trusted
accountant, lawyer, financial adviser, etc.,
you'll greatly minimize the risk. The best caveat
to bear in mind is: "if it sounds too good to be
true, it probably is."
Watch out for the Ponzi and Pyramid.
In their eagerness to make a lot of money
quickly, many people and millions of dollars
every year are sucked into Ponzi schemes and
pyramid deals. In the former, expect to lose your
money, and in the latter there's a very high
probability that you're wasting time and money.
In the 1920s Charles Ponzi invented a simple,
alluring investment fraud that's still practiced
today. In its simplest form, a swift-talking
promoter will ask you to give them, say $5,000 to
invest in a spectacular, usually secret,
investment to which the promoter has access. They
promise a spectacular return of, say 20 percent
in three months.
At the end of the three months, they offer to
deliver $6,000 (your investment plus your return)
but suggests that you let it all "ride" for an
even better return in another three months to six
months. What you don't know is that there is no
investment. The promoter is simply gathering as
much as they can from as many suckers as they can
convince. Then they have to pay Peter, it comes
from Paul. Eventually, the promoter disappears
with the bulk of the "investment" money.
A Pyramid scheme is an illegal type of multilevel
sales- except usually there is no product sold.
You are asked to pay ($500, $1,000, $10,000 etc.)
to become part of the pyramid. The amount of your
payment to the promoter determines your position
level in the pyramid and "allows" you to promote
the pyramid to others. The more people you bring
into the pyramid, the higher you rise and the
closer you get to the big payoff.
Financial Risk
For most investors, financial risk is the most
immediate one. It centers on the simple question,
"If I put my money into this investment, will I
at least get my money back?"
Your best protection against financial risk is to
explore any investment to the point where you
understand the factors that risk and/or secure
your principle. When you buy a common stock, for
example, the financial risk is tied to the credit
and operating histories of the company issuing
the stock.
So you analyze the firm's financial capacity
(ability to generate income). A firm that can't
pay its debts or has a low financial capacity and
a comparatively high financial risk. A company
with earnings high enough to pay fixed costs many
times over is thought to pose a lower financial
risk.
Generally, such vehicles as certificates of
deposit, commercial short-term paper, federal
savings bonds and Treasury securities are
considered of low financial risk. Whenever you
evaluate the risk inherent in a given investment,
ask yourself:
1. What kind of risk is involved?
2. What is the extent of this risk?
3. Is the potential return worth this risk?
By first learning a set of criteria with which
you can evaluate an investment, and then
considering those objectives in light of your
personal factors, you've begun acting like an
investor.
Steven Boaze
http://www.boaze.comPrivate Reply to Steven Boaze (new win) |
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