Only Invest in What You Know

The Ripoff Alert is a new series appearing once each week on Fridays. It alerts you to the latest scams and ripoffs trying to get between you and your money, and gives you information you need to stay safe. This is #20 in the series. 

Investing is a topic that makes many of us squirm. It can be incredibly simple or mind-numbingly complex. What gets us in trouble so often is that we try to invest in something we don’t understand.

Warren Buffet, the billionaire investor, is famous for his practice of investing only within his “circle of competence”. To us common folk that means we should only invest in what we know.

During the big run up of tech stocks in the late ’90s, Buffet sat out of the game because technology wasn’t an area he was familiar with. Instead, he continued his tradition of buying undervalued stocks. As others were picking up the pieces after the bubble burst, Buffet maintained his strategy and limited his losses.

Think about the various types of investments available to us. Stock options, derivatives, commodities, exchange traded funds and so on. The reality is, these investments are very complex and aren’t suitable for most people.

Investment opportunities presented to us by friends, family, neighbors or people at church can likewise be difficult to understand. For every big Ponzi scheme reported in the news there are a hundred smaller ones that don’t make headlines. I’m not saying your pastor is going to approach you about earning 2% per day on your money, but the people who run these scams rely on trust and familiarity you may have with them. They know your guard is down.

Before doing any type of investing, understand how the company operates, how they earn money and who their main competitors are. Take a look at their financial statements. Is the business growing or is the customer base shrinking? What are the risks and opportunities in the industry? This knowledge helps you make an informed decision about whether you should invest.

Investment scams have been around since we started using money to pay for things. But never before have we seen the range and complexity of investment scams that exist today. The recession and the resulting loss of individual wealth have created a perfect opportunity for scam artists to craft false promises of oversized returns on your money. Because of their complexity, the new scams are more difficult to detect.

Remember Warren Buffet’s simple rule, and know that there are no shortcuts to building wealth. It comes little by little over many years and decades. The best way to avoid these scams is to do your research and stick with investments you understand.

Beware of Investments Offering Oversized Returns

The Ripoff Alert is a new series appearing once each week on Fridays. It alerts you to the latest scams and ripoffs trying to get between you and your money, and gives you information you need to stay safe. This is #17 in the series. 

Trick question: What’s an easy way to guarantee a 10% return on your investments? Well, if I were a smooth criminal trying to make off with your money, I’d tell you I knew of a business that was about to make it to the big leagues. I’d convince you to “invest” your money before that happens. You’ll double or triple your money in just weeks! And with almost no risk!

Many of us are looking for that path to easy wealth. We badly want it to exist, and in some cases are willing to risk everything we’ve worked hard for to make a quick buck.

The truth about investing is that if you want a large return, you’re going to have to accept some level of risk. The larger the return you want, the larger the potential risk you have to take on. Anybody who tells you otherwise is trying to clean out your wallet.

The opposite is also true. If you’re unwilling to accept much risk, you have to settle with a lower return. Don’t be fooled into thinking you can have only upside with little or no potential downside.

“But I Need to Catch Up!”

Unless your time horizon is 10 years or longer, there’s no place you can put your money right now and have it grow more than about 1%. I know it’s pathetic. We all realize that won’t even beat inflation. But one nice side effect of these times we’re in is that if somebody comes along and tells you they can earn you 15% a year guaranteed, or 2% per day, or any other number that seems too good to be true, you know they’re lying. Such rates just don’t exist, today or ever.

I know it’s tempting to take the bait. You lost 30% of your nest egg in the recession and you need to get back on track. But the criminals will make off with your money, leaving you without the 15% return or your original investment.

Think about this: In an era where banks offer 1% per year on savings accounts, how can anybody legitimately offer 2% per day? Not gonna happen.

They’re Just So Sly

Fraudsters use online bulletin boards, newsletters and emails to alert you to these “can’t lose” deals. The internet allows them a curtain of anonymity that emboldens them to make audacious promises. But if this investment were such a great deal, why would they be telling us? Wouldn’t they just invest all of their own money if they truly believed it was a good deal?

You have to be careful with affinity fraud as well. This happens when someone you know and trust, such as a church leader or family member, tries to get money out of you for illegitimate purposes. It’s easy to let our guard down around those we trust. But when someone starts asking for your money you need to start asking questions.

So back to our trick question. The answer is there’s no way to guarantee a return of any percent on investments. By its very nature, investing is about taking on risk. It’s about taking chances. There are no guarantees with investing. 

How the Crisis in Europe Affects Your Wallet

Europe is in crisis mode, and nobody seems to care.

Several countries have borrowed and spent much more than they’re able to pay back. Central among them in Greece, which is in danger of pulling out of Europe’s common currency, the Euro.

Greece badly needs a bailout, but European leaders sharply disagree about the best path forward. On one side is Germany, Europe’s bankroller, who swears by the austerity measures they’ve implemented in their own country since the recession began 5 years ago. On the other side is a growing number of leaders from other countries, who believe it’s time for a different solution to the region’s troubles.

But why does this matter to us here in North America? Aren’t they across the big pond, thousands of miles away?

Here’s something you may not have considered. Europe accounts for 21% of all US exports, according to the Office of the US Trade Representative. That means over one fifth of all goods and services produced in this country are purchased by someone in Europe. If European countries and citizens are faced with austerity, do you think they’ll continue to purchase at the same pace as they always have?

A slowdown in Europe directly affects our economic situation here. With Europe buying less, companies have less need for labor, so they don’t require as many employees. Up goes our unemployment rate. Investors lose confidence that Europe will be able to cover their obligations, so stocks move lower. Down goes your 401(k) balance.

All of this causes us to consume less here, which slows down economic activity, prolongs the recession and gives companies even less incentive to hire new employees.

Another interesting trend is that policymakers have become the primary market influencers. Investors are now reacting to their perceptions of policy changes rather than economic data like retail sales and corporate profits. Because governments around the world have intervened to such an extent in the financial markets, the economy is now more dependent than ever on elected officials.

If you weren’t aware of how intertwined the global economy is, you should be now. As nice as it might be, you can’t control what goes on in other countries. Heck, we can’t even control what happens in our own country. But there are some things you can do in your own life to help you ride out these difficult and uncertain times.

Reduce the amount of debt you carry. Debt is a chainsaw to your finances. It cripples your financial health, giving your little margin for error. It requires a portion of your resources every month and gives you nothing in return. It adds pressure to meet obligations and stress and heartache when you come up short. Do everything you can to eliminate the amount of debt in your life.

Build an emergency fund. I’ve written about this several times on this blog. You need a pile of cash (preferably not stashed in the freezer) that you can rely on in a pinch. Start with $1,000 in an online savings account. Then build it to one month of living expenses, then two months and so on. This is your insulation against the bumps in life.

Watch your spending. You can make a budget, track every penny that you spend, or even put your credit cards in a block of ice. Whatever works for you. The point is to think about each purchase and how it makes your life better.

Save for your future. If your employer offers a 401(k) with a match, you have no excuses about why you’re not participating. Contribute up to the match and put the rest into a Roth IRA. Even with the markets on a roller coaster, your best chance of beating inflation is a diversified, low-cost portfolio of stocks and bonds. My favorite are the target-date funds. If you’re not sure how much you should be saving, see this post.

Who knows what will happen in Europe. But one thing is certain – it’s time to get back to basics. Following these tips helps you insulate your finances from the drama that’s playing out in Europe.

Are you worried about the crisis in Europe? What are you doing to protect your finances?

Photo by pbs.org

Teaching Your Kids About Money

Kids today are woefully unprepared for many financial decisions they will have to face. To prove this fact, ask any high schooler what a budget is. I’m willing to guess that about half will stare blankly at you as their eyes glaze over, and the other half will say something along the lines of, “It’s something Mom and Dad fight over all the time.”

Part of the problem is that some parents aren’t sure how to approach the subject with their kids, so they just avoid it. They may not be very good with money themselves. Other parents may assume kids will learn important lessons about money outside the home. Whatever the reason(s), kids aren’t getting the financial education they need.

LearnVest lists 9 money lessons financial experts teach their kids. Obviously we’re not all financial experts, but I want to talk about a few of these I believe any parent can handle:

2. Money is about making choices

Every time we spend a dollar we are making a choice. We are choosing to trade our life energy and resources for a product or service we hope will enrich our lives. By using our money for Item A, it means we’ll have to do without Item B for the time being. Also, by choosing to buy Item A, we’re choosing not to invest that dollar for the future or to give it to charity. This is why it’s so important to evaluate our needs and wants, put them in proper order by making a budget, and only buy our wants after our needs are taken care of.

3. Delaying gratification can pay off

Let’s say you really want to buy an item costing $200, but you only have $100. You could buy a $100 item that you like or you could wait until next month, save up the extra $100, and get the item you really like. In order to do this though, you have to go a month without any items. That takes discipline and a willingness to delay gratification until you can afford the item you really want. Alternatively, you could invest that $100 at the beginning of the year and have 7% more – $107 – at the end of the year given a 7% interest rate. To get that extra seven dollars though, you have to wait all year. Is it worth it?

6. Work for what you want, and it will mean more

For my 17th birthday my parents bought me a used car. Because it was my first car and it meant I didn’t have to ask my parents for rides anymore, I was pretty excited. I took care of that car and enjoyed having it during my senior year of high school. My parents sold it when I was in college and I went almost seven years before I had my own car again. At 24 I bought a car by myself for the first time. I still drive this car almost every day. Even though it’s not the newest or nicest car out there, the sense of accomplishment I get when I’m behind the wheel is greater because I paid for it myself.

8. Budgeting is a family affair

Do you involve your kids when making financial decisions? If not, you’re missing out on a chance to teach them how you make decisions about where your money goes and why. When they’re old enough to earn money doing chores around the house, get them a piggy bank like this and require that a portion of the money goes into each of the four slots: save, spend, donate and invest. Explain the importance of each category and get them excited about saving.

9. A little goes a long way

Just a few examples set by financially responsibly parents can set kids on the right track. Show them your retirement accounts and explain that a portion of every dollar you make is saved for when you choose to not work anymore. Show them what you’re saving up for whether it’s a family vacation, new furniture, or Lasik. Explain that by waiting and saving up a few extra months you can avoid credit card debt and instead rely on savings. If you donate to a charity, explain why.

Always look out for opportunities to teach your kids about money and finances. You’re the best example they have.

Photo by enemyofdebt.com

Gold at $1,800 an ounce: What you need to know

Since 2002, the price of gold has risen from under $300 an ounce to about $1,800 an ounce. That’s an increase of 538%. Gold prices are now the highest they have been in over 30 years.

When the market is down and uncertainty is high, people tend to look for a place to stash their cash outside of the stock market. Investment in gold and other precious metals tends to increase significantly during tough times. But I have a warning for anyone considering putting some or all of their money in gold.

Gold and other precious metals are speculative investments. The price increases as a response to higher demand during uncertain times. Those who buy gold are essentially betting (speculating) that the market won’t improve anytime soon.

If you insist on buying gold, avoid buying physical bars or coins. Aside from the storage issue, there are high costs associated with acquiring physical gold. I recommend instead investing in gold Exchange Traded Funds (ETFs.)  To maintain a balanced portfolio, don’t invest more than 5-10% of your assets in gold and other precious metals.

Gold prices are approaching all-time highs. Who knows how much higher they will go. Do you want to get caught in the next bubble?