Being Vigilant in the World of Alternative Investments
As forecasts for future returns on publicly traded investments begin to dip, it can be tempting to turn to “special” private deals that claim to offer higher returns. These types of deals usually include investments in things like real estate, private equity, and start-up firms, which are known in the financial world as alternative investments because they are alternatives to traditional stocks and bonds that are publicly traded on a regulated exchange. While some may actually be good opportunities, the alternative space is also full of incredibly risky deals and, in some cases, outright scams. What follows is a list of things to look for when reviewing a potential opportunity and red flags to be aware of.
A financial salesperson approaches you with “a great deal you can’t find anywhere else.”
Things To Consider:
Always be skeptical of special deals. A good question to consider is if the deal is so great and exclusive, why is the salesperson sharing it (as opposed to keeping it for himself)? If someone approached me and said this is the best car I’ve ever had - it works perfectly, it has great gas mileage, but I’d be happy to sell it to you - I would be pretty confused. Remember, if someone is selling you something, it’s because they expect to make money too. Don’t be afraid to ask the salesperson how they make money on the deal. You want their interests to be aligned with yours.
The deal is difficult to understand The return numbers are incredibly high
Your financial advisor sends you an advertisement for an exclusive, limited time only, real estate deal.
Things To Consider:
In this day and age, real estate deals are plentiful, but few are actually done well, particularly because there are so many unknowns. Whenever you’re considering a real estate deal, it’s important to really dig into the underlying research. There is no shame in asking a lot of questions and there is great value in recognizing your limitations. If you know you’re not an expert on real estate, get a second opinion from someone who is before entering into a binding contract that could lock up your capital for a long time.
There are a lot of pictures, but no numbers backing up the investment The ownership structure is complex and vague There is no mention of potential risks or the amount of debt that will be used There is a long lock-up period
A financial advisor offers to invest you in an up and coming start-up, claiming that the growth opportunities are endless.
Things To Consider
A good rule of thumb whenever you encounter a special deal is to recognize that if something sounds too good to be true, it probably is. While there are historical instances of investments that have had incredibly high returns, they are overshadowed by promises of incredible opportunities that have blown up and caused a lot of pain for investors. Start-ups have to offer high returns because they are incredibly risky and have a high probability of failing. If you are considering investing in a start-up because it’s something you believe in, one of the best ways to protect yourself is to not invest more than you can handle losing – don’t bet the farm. Ask yourself – if this investment doesn’t work out and I lose everything I invest, will I be ok?
The advisor offering the deal is connected to the start-up in some way, shape, or form and stands to benefit from you investing (this is called a conflict of interest and should be clearly disclosed by the advisor) The start-up is looking to raise 100% of its capital (if the company management itself has no skin in the game, it also has little incentive to succeed) You google the start-up after the meeting and can’t find a physical address/location The start-up hasn’t started yet
If you’d like to learn more about ways to defend yourself against financial schemes, check out these third-party resources:
*A version of this article first appeared on our blog in June of 2015.