BOSTON – It has long been said that the two emotions that most drive investors are fear and greed.
When it comes to falling victim to common investor traps, however, there's an even bigger emotional problem, and it's the investor's lack of fear that they are about to make a blunder.
The North American Securities Administrators Association last week made its annual forecast of the "13 most common ways investors are likely to be trapped in 2006." The list — prepared by the group's Enforcement Trends Project Group — is not entirely a rogue's gallery of rip-offs and scams; in several situations, the list includes legitimate investments that simply represent a bad fit for the bulk of investors who try them.
Clearly, the scams in the group play upon fear and greed, either trying to entice the consumer with the promise of oversize returns or pledging ultimate safety with reasonable-but-unrealistic returns. In each and every case, a consumer or investor who was more scared of making a mistake than desirous of getting money into play could have stayed out of trouble with a few minutes spent on a phone call, doing a Web search or simply asking more questions.
Here's the NASAA list of investor traps, listed alphabetically. In almost every case, simple skeptical questions should be enough to keep you safe:
1. Affinity fraud
Con artists frequently target close-knit religious, political or ethnic groups, but legitimate financial-services companies also pursue people by affiliation. Your university may cut a deal with an insurance company, for instance, to offer life insurance (where the college gets a sliver of your premium dollars).
As a general rule, however, the affinity group hasn't done much due diligence in vetting the investments (and with some fraternal organizations, all a scam artist needs is a mailing list or an insider contact to make it seem like they are part of the group).
Throw out the emotional tie to the group you're involved with and ask, instead, one simple question: "If there was no affiliation here, would I be looking at this deal and consider it a prudent, cost-effective financial move?"
An unethical practice where a securities pro makes excessive, often unnecessary trades to generate commissions, churning typically occurs in accounts where brokers have discretion to make moves without the client's approval. An adviser who is churning customer accounts doesn't want to get caught, and typically will avoid accounts where regular questioning increases the potential for being discovered.
Review accounts regularly and demand answers if the trading pattern seems odd or excessive.
3. Equity-indexed certificates of deposit
Equity-indexed CDs have returns that are linked to a stock-market index, but gains depend on that benchmark and are not insured by the Federal Deposit Insurance Corp. If the stock market is down, the return may be zero. That doesn't make them a bad investment for everyone, but they are frequently unsuitable for the people buying them, often senior citizens looking for a way to goose their returns.
If you are the wrong kind of investor for these products, that should come out simply by asking "What's the worst that can happen?"
4. Oil and gas investment fraud
These deals typically offer a chance to invest in a drilling enterprise purportedly about to strike it rich.
Unless you're the kind of high-net-worth investor who has invested in successful limited partnerships in the past, ask "Why am I being offered this deal?" If you don't have a great answer, you don't have any reason to go further.
5. Personal-information scams
Being robbed of your personal data can be as bad as falling for an investment fraud. Identity thieves often pose as "senior specialists," offering help in performing basic financial tasks.
Before giving out financial or personal information of any sort, ask "Do I really need to provide this much detail, and do I know the people I am giving it to sufficiently to trust that it will be properly cared for?"
6. Prime bank schemes
Promising high-yield, tax-free returns from offshore trading of "bank debentures," this is a flat-out rip-off. The debentures don't exist and the yields are illusory. These are sold as being only for high-net-worth investors.
Again, ask why you're so lucky to be offered a deal you've never qualified for before.
7. Pump-and-dump schemes
If you're being offered the chance to buy a stock right as it is about to pop, ask yourself why you'd be so lucky as to get this information from a total stranger. Yes, someone is making money on these deals, but unless you have a good answer to that question, chances are that it won't be you.
8. Recovery rooms
If you lost money to a worthless investment, a recovery-room operation will only make things worse. The crooks who know you were a sucker once know you are still vulnerable, as you are anxious to catch up. They'll promise, for a fee, to attempt to recover your money.
It may sound good, but it will amount to nothing but more heartache. Ask yourself "If I was fooled once, could I be fooled again?"
9. Registered high-interest promissory notes
Typically, higher rates of return mean higher risk. If you see advertised publicly what looks like a great return from an institution that you've never heard of, ask "Is this insured?" and "Do I understand the risks?" Generally, the "risk factors" in the data you get on these investments will give you the willies if you read them.
10. Sale-and-leaseback contracts
These are investments structured to look like you are buying a piece of equipment, like an automated teller machine. Typically, the machine is located in some remote place and you're supposed to make your money on high fees. But you'll pay through the nose for a servicing deal. And when you try to exercise the option to sell the equipment back — when the deal isn't working — you may learn that the equipment never existed.
With any business opportunity, ask "Is this a business where I can do the jobs myself?" and "If I must rely on someone else to run this business for me, do I know enough about them to have faith in the deal?"
11. Self-directed pension plans
This is a tricky one, as it's tough to spot the frauds from the legitimate investment situations. That said, many securities frauds require that the consumer withdraw funds from legitimate investments to move into a worthless scam (often involving the previously noted prime bank or sale-leaseback deals).
Do not give up on existing investments — especially in structured retirement investments — easily. If most folks you know aren't going the route you are considering (and they're not), ask if you're smarter than the rest of the world or if you're simply being outsmarted by a rogue adviser.
12. Unsuitable recommendations
An investment is only good if it's right for the customer buying it. Just because an adviser is selling you something doesn't make it right for you. If the investments you are being pitched routinely make you nervous, ask whether your adviser truly has you in mind when they come forward with an idea.
13. Variable annuities
Tax-deferred investments that typically use mutual funds inside of an insurance-policy wrapper, variable annuities are completely legitimate investments. That said, regulators worry about their popularity in the advisory community, noting that they carry high commissions, heavy surrender charges and typically are suitable only for a small percentage of the population.
This is an investment that you should not buy unless you understand it — and the potential drawbacks — completely. The final question to ask before buying should be "Have I asked enough questions?" because if you can't explain why you are doing this to your heirs and loved ones, you don't know enough to follow through and buy.
Copyright (c) 2006 MarketWatch, Inc.