How Not To Get Ripped Off In Investing Or If It Sounds Too Good To Be True, It Probably Is

I must admit, I’ve generally found it difficult to comprehend how so many people can be swindled by con artists like Bernie Madoff. Do people really believe that steady, guaranteed 12% returns really exist? If so, why? Over the past few years, I’ve come to realize the simple truth: people fall for these scams because they want to believe these investment opportunities can make them rich. Hope is a powerful motivator, to be sure, but it’s also an extremely effective destroyer of good judgement. If somebody wants or needs to believe something good will happen if they just follow this one system or invest in this one investment, all without risk!

Sadly, no amount of financial wizardry can undo the fundamental relationship between risk and return. Simply put, low-risk investments tend to be low-paying investments while high-risk investments tend to be high-paying investments. Any investment product proposing to violate this fundamental law of finance is most likely a scam! Put another way, you aren’t going to earn high returns with a low-risk investment. You’re just not. Accepting this statement as undeniable fact will go a long way towards helping you avoid being ripped-off. If you train yourself to expect high-return investments to also be high-risk investments, your BS detector will immediately go off anytime some scammer tries to convince you otherwise.

Principles For Avoiding A Scam (Any Scam)

If It Sounds Too Good To Be True…

Seriously, if it sounds to good to be true, it almost certainly is. Many people who fall for scams had this warning bell going off in the back of their minds the entire time but ignored it. Don’t ignore it.

Disbelieve Theories That Sound Logical But Don’t Have Independent Data To Back Them Up

Con artist is short for “confidence artist,” meaning they are skilled at gaining the trust of others. And it’s obviously easier to scam somebody who trust you than somebody who distrusts you. Hence, the best defense against con artists is to avoid any investment or system inherently depending on trust: trust of an investment manager (this rules out most active funds, btw), trust a salesman’s product will do what he says it’s going to do, etc.

But without trust, it’s impossible to accomplish anything. So if you can’t take people at their word, how do you know when something is legit? Simple: independent data. This could take the form of independent reviews of a product or service on the internet, consulting a trusted expert in the field (perhaps your nephew is also a financial advisor), or even an academic study on the topic by some esteemed professor. The point is that you should never take anybody’s advice when they have a direct financial incentive for you to follow that advice. If you ask an insurance salesman if you need more life insurance, he’s probably going to say yes. Similarly, a barber will probably tell you that you need a haircut. If you can’t verify the accuracy of any claim independently of the person making the claim, it’s best to pass. If a con artist can’t get you to trust him, he can’t con you.

Be Skeptical Of ANY Claim Regarding Low-Risk/High-Reward Investment Opportunities

As noted above, a fundamental relationship exists between risk and return. A con artist can no more circumvent these rules than defy gravity. Any claim that a high return can be earned with little risk should be met with intense suspicion for this violates one of the fundamental laws of finance. Do you really think you can earn a 40% return on your money with no risk from some guy

Always Compare Past Performance Claims To A Reasonable Benchmark (Usually Not The S&P 500)

One common trick salesmen use is to compare the performance of their product to an inappropriate benchmark, often the S&P 500 index. Now if the investment in question invests solely in the large-cap blend portion of the style box, the S&P 500 is probably a reasonable benchmark. Otherwise (and this is usually the case), it’s probably not. Who cares if an investment trust owning mostly small-cap emerging market stocks beat the S&P 500 over the past 10 years? That is an apples-to-oranges comparison with the sole intent being to trick you into thinking the investment you’re being pitched is better than it really is. This is a huge red flag because if the investment opportunity were really as good as claimed, they wouldn’t need to resort to misleading statistics in order to sell it.

Ask Yourself: If This Is So Profitable Why Do You Need Me?

This one should be obvious. Have you seen those banner advertisements around the web promising 20% monthly returns (or some other ridiculous number)? Chances are, you have. Now ask yourself this: if these people could really earn 20% per month on their money, why do they need to take on external investors at all? Earning 20% per month, a $1,000 initial investment would yield over $411 BILLION in 10 years! By investing only $1,000 of their own money, these “investors” could become the richest person in the world 10 times over within a mere decade. Tell me, with prospects like that, why do they need your money?

I’ll tell you why, because their system doesn’t work. Their profits come from scamming you!