By CHUCK JAFFE
In the past decade of writing about stupid investments, one question I was asked most often by readers: "How do I become a smart investor?"
I can answer that question for average investors in three sentences, totaling just eight words.
Know yourself. Understand what you're buying. Be careful.
Follow those instructions and it's hard to make big investment mistakes.
The second most asked question was tougher to answer, because it was about what a stupid investment looks like, or how to spot one. There's something of an art to this. Two years ago at a big industry conference, I told a friend I was hunting for column fodder and he asked how I would decide. I told him I would wander until I smelled it, and stop when I stepped in it.
Today, I want to leave you with an enhanced sense of smell.
Since early in 2003, Stupid Investment of the Week has examined the conditions and characteristics that lead average investors to choices that are "less than ideal." Since no one sets out to make poor decisions and buy something lousy, the idea here typically was to deconstruct the case for purchasing an investment, highlighting its potential to go wrong. (And I will continue writing about bad investments/judgment, but without the constraints imposed by the SIOTW format.)
Bad investments -- and the problems that lead to them -- aren't going anywhere. The investments examined over the last decade ranged from good companies that, for a time, were bad stocks to inherently, irrevocably flawed investment products and seemingly everything in between. While more than 20% of the investments covered are gone by now, some live on, and probably will forever, kind of like investment cockroaches, always there to feed on those who are sloppy in their financial housekeeping; for every stupid investment that disappeared, there has been at least one new concept or issue that filled the void.
While not every bad investment idea comes with high-flying red flags, there are some conditions that routinely come up that should be an indication that you're headed into the danger zone. Read The stinker investment sniff test
The harder it is to make money after you pay the freight, the more likely you've got a poor investment choice. That's not to say some mutual funds, insurance policies and other securities can't overcome costs, but most don't, especially over long periods of time.
Investors must recognize that there is no free lunch; one way or another -- whether the costs are out in the open or hidden and buried amid complex details -- you're the one paying the costs, and no one would sell it to you if they couldn't make something on the deal.
It's not that appealing to a wide audience is bad, but it doesn't necessarily lead to great investment products, and consumers often can get a better deal just by putting a little individual effort into it.
For example, most insurance policies pitched on television -- the ones that promise coverage with no questions asked -- are priced as if the buyer already has one foot in the grave. If you are otherwise uninsurable, that might be okay, but the vast majority of people buying these policies could get more coverage, pay lower premiums or both simply by not jumping in with the crowd.
While there are times to run with the herd, it's important not to follow along with them mindlessly.
Misdirection, shouted-down questions or dissent, or problems swept under the rug
If you want to know whether you are being sold the equivalent of financial swamp land, be sure to ask about dry basements or re-sale value.
If the answer -- whether from the sellers or the people already in the neighborhood -- comes back, "Look at the lovely kitchen," or, "Only someone with a loser's attitude would ask that," run away.
If you ask enough questions and the responses are hinky, nervous, worried or hyper-aggressive, there's trouble. If everything doesn't add up in your head, you deserve answers to your specific questions.
When the people supporting an investment aren't giving you straight talk, they're hiding something; no matter what it is, you're not going to like it.
This is not so much about engaging in market timing as it is being aware of where an investment really is at the moment you buy it.
A key part of the SIOTW methodology was looking for investments where there was a case to buy, but the very real potential for a security to take a dive before it reached its potential. Studies show that investors typically bail out if an investment declines more than 20% from their buying point; even if a stock takes off from there, all the investor experiences is the loss.
Too often, investors look at positives without recognizing the factors that could delay the success they foresee. For example, investors may love the concept behind a popular business, but may not recognize that short-sellers are swarming the stock, or see a stock that has fallen into bargain territory without considering what might drive the price down further before it can rebound.
Investors love the idea of "buy low, sell high," but have trouble executing it, all too often getting it backwards.
Even if your investment premise looks right for the long term, it's important to recognize the detours that could crop up on the path to success, or you might not complete the journey.
A never-give-up sales pitch
The very first Stupid Investment of the Week was investment notes from American Business Financial Services, and that firm continued to send invitations to invest every few weeks, right up until the firm filed for bankruptcy protection and suspended sales and redemptions for investors.
Likewise, if you request information on the Gerber Grow-Up Plan -- a lousy life insurance policy on children -- or the AARP Guaranteed Acceptance Life Insurance plan (a bad idea for grown-ups), you may be in for mailers until your loved ones are collecting on your life insurance. Read Looking under the cloak of respectability
An extension of bad timing, just with more emotion factored in. All too often, average investors only find out about an investment after it has come into vogue, by which time it may be ready to hit the skids. It's important to remember -- and consider -- that every investment can go wrong, eventhe ones that appear to be can't-miss opportunities.
Poor governance and questionable investment premises
Sometimes, an investment stinks just because of how it is constructed, the style of management or the ethics of executives. It may be a great marketing idea that's a poor investment concept.
These flaws aren't always evident at surface level, but when uncovered can quickly turn an investment that looks good into an ugly situation.