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6 ways to protect against investment scams

February 21, 2013

| MoneyRates.com Senior Financial Analyst, CFA

It can take an entire career to build adequate funds for retirement -- and only a few minutes to blow those savings.

According to The New York Times, regulators across the country are reporting a rash of investor complaints against investment schemes gone wrong, from the overly speculative to the just plain crooked. Unfortunately, one bad decision of this sort can wipe out years of diligent saving.

The search for better yields

Why is this happening now? Surely, in the wake of Bernie Madoff, aren't investors wise to the tactics of predatory investment professionals? They should be, but a combination of two things is keeping the pressure on ordinary investors to venture into riskier and more exotic investments. For one thing, with savings account rates less than 1 percent, income-starved investors are desperate for alternatives. Meanwhile, since competition and online trading have squeezed down the margins on conventional investments, many brokerage firms are looking for fatter commissions by selling more complex investment programs.

How can you protect yourself in this environment? Here are six things to remember:

  1. Not much is guaranteed. Apart from federally insured deposit accounts and directly held (as opposed to owned through a mutual fund or other vehicle) Treasury bonds, very little in the financial world comes with a guarantee that you can count on. If someone tells you that higher returns on other investments are guaranteed, you should shy away from both the investment and the person pitching it.
  2. Higher yields mean higher risk. Not all high-yield investments are scams. Lower-grade bonds yield more because there is a greater risk that the issuer won't meet interest and principal payments. This can be a worthwhile risk to take, but just remember that whenever someone mentions "high-yield bonds," they are talking about what are commonly known as junk bonds.
  3. Packaging can be expensive. The more layers an investment has, whether it is real estate properties bundled into a partnership, mutual funds bundled into a fund-of-funds program, or securities bundled into an insurance wrapper, the more middlemen are likely to be involved, each taking a cut that reduces your eventual return.
  4. Private investments remove many key protections. When a stock is listed on a major exchange, or a mutual fund is registered with the SEC, it means that the organizations behind those investments have to meet certain requirements for financial reporting. Private investments are often less transparent, and can leave you with less legal recourse if there is trouble.
  5. Complexity can obscure serious issues. It's fine to hire professionals who know investments better than you do and have more resources to follow the financial markets. However, if your adviser can't explain how an investment works in fairly simple terms, then you may want to beware. Complexity can be the smoke-and-mirrors that hides a scam.
  6. Personal references only go so far. Simply knowing someone who has had good results from an investment or an adviser shouldn't be good enough. From Ponzi to Madoff, early payoffs have been used to rope in wider circles of investors. Invest with federally registered advisers in registered investments, and even then always keep your guard up.

The simple truth is that bank rates today are not very inspiring. However, when you measure the possibility of a catastrophic loss against the security of FDIC insurance, savings accounts suddenly look more attractive again.

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