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Avoid Being Scammed!
by Bill Jones
The biggest risk in investing is not stock market risk, or interest rate risk, or credit risk (the inability of a borrower to repay). It is SCAM RISK. With the other risks, you rarely lose more than 30%, and you usually recover most of that within a few years. Scam Risk can cost you over 90% of your money and you usually never get it back. Besides, Scam Risk is more embarrassing. But there are ways to make it nearly impossible to be scammed.
Is Having A Financial Advisor A Good Idea?
I believe that the majority of investors need a financial advisor. The safest choice is an hourly-fee-only financial advisor who understands tax situations as well as markets. You pay a high per-hour charge; but for most people with well over $100,000, it is worth spending $1,000 a year or so (plus about $2,000 for the initial consultation) for such advice. And buying funds with sales loads will cost about as much in the long run anyway. However, people with less than $100,000 to invest may not find it cost effective to use a fee-only advisor. In that case, they may need to work with a financial advisor who is compensated through commissions, or sales loads.
Even a seemingly-honest financial advisor may be a fraud or may churn your account down to almost nothing (through very frequent high-commission trades). The vast majority of financial advisors are honest and trustworthy, but so are the vast majority of church treasurers, and a few of them have been known to betray a trust and run off with funds entrusted to them. Do you think you can see through a scam artist? Remember that the primary qualification to be a scam artist is to be a person about whom people say, "I am a good judge of character and I can tell that this person is clearly trustworthy, friendly, competent, and honest."
My opinion is that the advisor should not manage the assets. Rather, he should instead help the investor learn how to manage them himself and keep on track to a reasonable return with moderate risk. He can provide moral support in down markets. One criterion to use is to find out how often a prospective advisor recommends the use of Vanguard funds (or a close equivalent such as T. Rowe Price or TIAA-CREF). These are clearly the best (i.e., low price and high quality) generic mutual fund investments, though not necessarily the best actively-managed funds. I personally would distrust a fee-only advisor who would never recommend them.
What Do I Do To Avoid Scams?
One way to avoid scams is to be very knowledgeable, to be very cynical, and to trust no one. A simpler way is to always follow four principles:
1. Never make a check out or send money to anyone other than one of the 20 largest fund families or the 3 largest fund supermarkets nationally. Since this includes both load and no-load families, and most of them will handle individual stocks and bonds for you, this does not significantly restrict your ability to make good investments. But it does restrict your ability to make bad investments.
2. Always get reports of your assets directly from the company, not solely indirectly through your advisor. Anyone with a laser printer can fake reports. At least call the company directly every quarter or so to check what they say your balance is.
3. Never give anyone except your spouse the power to make changes in your investments without your prior knowledge and consent. Your accounts should not have an advisor, broker, or relative (other than your spouse) as potential payee. Exception: in some cases, it may be desirable to trust a very close relative or a court-appointed executor. A few people may find it unavoidable to at least give their financial advisor a limited written Investment Policy Statement laying out what changes in investments are permissible, but NEVER give him the power to put your assets in his own name. The written policy statement protects his reputation from verbal misunderstandings.
4. Hang up on cold callers. I just say, courteously, "I'm not interested, thank you, good-bye" and hang up, while holding the earpiece away from my ear so I can't hear any counter-arguments or statements meant to bait me into continuing the conversation.
The first two points might seem distrustful and insulting. Not at all; when it comes to your money, this kind of caution is not distrustful, it is only common sense. Any good financial advisor should admire your acumen in these matters, not be offended, and be willing to work within those parameters.
Some people may object to the third point; their advisor has made it clear that he "needs" this power to react to market changes on a few hours' notice. My opinion is that no one should ever allow their assets to be used for short-term timing of the market unless they themselves fully understand the logic behind the decisions and make those decisions themselves. Otherwise they should stick with a long-term plan such as constant-ratio asset allocation.
What If My Advisor Says He Can Beat The Market?
If your advisor/broker assures you that he has the competence to get you 5 or 10% over the market averages, as long as you let him control your investments, consider that there are two possibilities:
Or at the very least, have him put in writing that he will produce written statements every month proving that he has at least $100,000 of his own money for which he is making the same investments with the same timing that he makes for you. (If he hasn't made his first $100,000 yet in the stock market, he doesn't have enough experience to advise anyone on short-term timing.)
Anyone who is honestly sure he can get you 5 to 10% over normal market returns will leap at the chance to do this; it's a no-brainer. How can he lose?
Don’t trust anyone who assures you he can substantially beat the market with YOUR money, but back-pedals strongly when you suggest he put up HIS money.
William C. Jones, Jr. was born in Chicago in 1944. He obtained the Ph. D. in Mathematics from Purdue University in 1969. He has taught full-time in the Departments of Mathematics and Computer Science at Central Connecticut State University since then, except for a year teaching at the Bundeswehr University in Hamburg, Germany in 1981-82. He earned a Master's degree in Computer Science in 1989 and has had three textbooks in Computer Science published, by Harper & Row and by John Wiley.
Dr. Jones has been investing all of his retirement assets in equity and bond mutual funds since 1974. He is married to Virginia, who also teaches Mathematics and Computer Science at CCSU, and they have a daughter working on her Ph. D. in Mathematics. Dr. Jones is also a frequent contributor to the MFI newsgroups.
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