In the world of investments, it is sadly common for sellers to make claims that are just not accurate, realistic or valid. They promise things that literally cannot be done or at any rate, won't be done effectively or usefully. Novice investors, and more experienced investors alike may be misled into thinking that just about anything is a good and well-managed investment. And one serious mistake can damage someone's financial security. But how can you differentiate between hype and reality?
Glossy, attractive brochures (or internet sites) and striking photographs should be dismissed as irrelevant to the investment process. They really do not mean anything. Enjoy looking at them, but don't take them seriously. Focus on the real information and offerings.
Flashy bar and pie charts may be accurate and useful, or just the opposite. And it is not so easy to differentiate between the two. For instance, it is simply deceitful to attract investors into equities by showing a gently rising value line above a very flat and boring bond-performance line. This unfair comparison can easily mislead investors into thinking that the broker or firm in question has done a great job with equities and that they are an outstanding investment. An experienced investor will know that, over time, equities generally perform better than bonds but with far greater volatility and uncertainty. There are also long periods throughout history during which equities are more bother than they are worth. Accordingly, the proportion of a portfolio going into equities must be considered extremely carefully.
Product complexity lends itself to misleading advertising. Structured products can be remarkably difficult to understand, but to market them simply and appealingly is not difficult. Inexperienced investors are particularly vulnerable.The seller has an obligation to ensure that complexity is not misused to mask risk. The conventional wisdom is not to buy what you can't understand. However, this advice cuts out a lot of potentially good investments. Make sure you get advice from someone you can really trust, preferably someone who does not stand to gain one cent from the transaction. (For more depth on what structured products are, refer to Understanding Structured Products.)
Simple, Yet Misleading
Historical returns are one of the most common problems. Just because something has done well in the past, doesn't mean it will continue to do so. It may even mean the opposite. The market in question may be peaking or perhaps too much risk has been taken (hence the high returns so far) and the crunch is coming. In short, projections into the future are, by their very nature, unreliable. What matters is the nature of the product, not what the crystal ball tells you.
Guarantees must be treated with a similarly healthy suspicion. Such phrases as "risk-free," "safe" and "protected" may actually mean that you will earn next to nothing and might as well put your money in the bank. Or they may be just plain false. The protection may turn out to be inadequate or may not apply when you really need it.
Meaningless or Misleading Service Claims and Promises
Some firms exaggerate their competencies or the level of service they offer. For instance, a claim like "we believe that investment success requires regular monitoring and attention to the smallest detail" is great in principle. But many firms just do not do this, no matter what they imply. Likewise, promising to "maintain a close relationship all year round" is vague and often pretty meaningless.
Outright falsehood can also occur. For example, some brokers tell you how they predicted this or that crash or boom. A look at documents from the period in question may reveal that this is just not true. In the investment world, there is no shortage of such scandals. In his promotional material, one broker claimed that he had "believed the bull market was in its expensive and speculative phase," and warned his clients accordingly at the time. A skeptical journalist did some digging around and found that the broker had actually claimed that "the bear market was alive and well." (In addition to questionable advertising, read Understanding Dishonest Broker Tactics for other possible tricks you should be aware of.)
In almost all countries - certainly America and Europe - investment advertising is regulated. In theory, this obliges firms to disclose a minimum level of information and to advertise fairly. Nonetheless, in practice, this does not ensure consistently that the advertising investors read tells them what they really need to know. Unfortunately, regulation is not all-encompassing, and does not provide anything close to full or adequate protection. (Learn more about regulation in our article Financial Regulation: Who They Are And What They Do.)
There are a number of fundamental issues you should be aware of before you buy. First, you need to know exactly what the investment entails – is it equities, bonds, real estate or what? Furthermore, each of these categories has its own subdivisions. Second, you need to know the level of risk and the costs of getting in and out (or of simply staying invested). It is important to understand why you should invest in this right now. True market timing is difficult or even impossible, but it is generally clear whether a particular asset class is a relatively good investment or not at a given point in time.
Do It Yourself
You can do a lot by keeping your wits about you. But, realistically, this only applies to those with a reasonable level of knowledge and experience. Reading articles like this one or getting advice from a trusted source can help ensure you know the score. The media, the regulators and associated consumer organizations can help in this respect. But for the initiated, do your homework. It may be a pain and an effort, but the pain of getting it wrong will be far worse.
The Bottom Line
The ugly reality is that a large number of firms and brokers promote their services with the main or even sole objective of attracting customers and their money. The tendency to diverge from the straight and narrow is always there. There are a number of classic methods of making very ordinary or even bad investments sound good and there are new tricks and new bad investments emerging all the time. Regulation is therefore one of the main mechanisms for protecting the public. The other challenge is to educate the public but this has always been and will remain difficult to do effectively, efficiently and comprehensively. For those fortunate enough to be already reasonably well informed, make sure that you sort out the gloss from the dross before you hand over your money. (Also read Picking Your First Broker before choosing someone to handle your money.)