I recently wrote an article focused on how to identify and avoid dubious investments. But what about all those other investments out there that are legitimate? What do you do if you discover a potential investment that seems and sounds reasonable, and doesn’t have any of those telltale warning signs of financial traps? How do you go about ascertaining that it is the right fit for you?
Not all investments are scams looking for suckers. There are many legitimate enterprises that seek funding so that they can take their business to the next stage, or take advantage of opportunities in the marketplace. Once you have been reassured that the proposed investment is legitimate (see last month’s article re telltale signs and red flags), you need to analyze the type of investment and associated risk to see whether or not this is how and where you should be exposing your money.
Currently, returns on bank savings (which are close to 0% in the short term) offer scant percentage gains. And for those who are not content with the very safe savings option which generally equals very low rates of return, there are five questions that need to be asked by anyone considering new investments.
Question 1: How can I lose money with this investment? Identify all the areas of risk so that you truly understand how you can potentially lose funds that you have invested. If you don’t understand how it can lose money then you don’t fully understand the nature of the investment because all investments can lose money.
Once you understand the risks you can decide if they are acceptable, and you can then create a risk protection strategy. For example, if a significant risk is due to the fact that you will be transferring money directly to the investment manager as opposed to an independent custodian, you can try and negotiate moving money to an independent custodian, which would then minimize that particular risk.
Question 2: How realistic is the expected return? And what assumptions lie behind it? Look at the historical returns being quoted from the last few years. Are they the long term norm or are we at the height of a bull market? Investments that assume that a bull market (ie a market with strong positive returns) will continue for the next decade, even though historically bear markets appear every six years, should give you something to think about.
Question 3: What is your exit strategy? It’s very nice to make money, but unless you have a strategy regarding how to access that money and pay the necessary taxes, then the gains are on paper only. Ensure you also have a clear picture of how and when you plan to take your gains out of the investment.
Question 4: Are you using common sense? Does the investment make sense to you? Do you understand the mechanism by which you will be making money? Warren Buffet, who is possibly the world’s most famous investor, has made a practice of only investing in businesses he understands. And that system which worked incredibly well for him, works equally well for the rest of us.
Question 5: What is the background and history of each of the people involved? Do they have the necessary experience in the field or are they new to the industry? Why are they looking to raise money from you as opposed to contributing their own money? Make sure that wherever possible they are investing their own funds too. And assess their competency and honesty. There is a significant difference between being competent and thoroughly honest – make sure that those in charge of the investment possess both those attributes.
There are some very good investment opportunities out there. The key to locating them is by doing your due diligence. Ask yourself the questions listed above and ensure that the answers meet your requirements and risk exposure. If you feel ill-equipped to conduct the necessary due diligence, then contact a financial professional for assistance. Whereas on the one hand you obviously don’t want to be foolhardy with your money, you will also want to ensure that you don’t miss out on an investment opportunity that may well suit your requirements. Behatzlocha!