CFA, Director of Investor Education
On the fifth anniversary of Bernie Madoff’s conviction, it might be tempting to try and forget about investment fraud. After all, one of the most notorious con men in modern history has been locked away until Nov. 14, 2139. So does that mean investors are safe from fraud?
Unfortunately, there will always be bad apples in the financial system and if you have money to invest then you are vulnerable to potential fraudulent behaviour. Latest figures from the Canadian Securities Administrators show that 56 per cent of Canadians agree they are just as likely to be a victim of investment fraud as anyone else.
The following five steps will help to minimize your chances of falling victim to investment fraud and limit your exposure in the unfortunate case that you do.
1. Clearly understand the investment strategy
The venerable portfolio manager, Peter Lynch, consistently advises people to invest only in what they understand. Investors should be alert to the possibility that complex jargon often hides suspicious inconsistencies. Some investment opportunities appear alluring simply because they are described in impressive, complicated terms and of course as investors we want to appear smart so we often nod, smile and agree to something we don’t actually understand. Investment strategies and financial products should be clear and understandable, and the professional advisers that you hire should ensure you’re comfortable with them before you take the plunge.
2. Be wary of “sure things”, quick returns and special access
Legitimate investment professionals do not promise sure bets; remember there is no such thing! Scammers often make the combination of safety and high returns seem plausible by granting you “special access” based on your relationship with a mutual acquaintance or affiliation with a specific group. Be sure to judge investments on their merits alone — do your best to ignore the social pressure that can often lead investors to misery and remember if it seems too good to be true, it probably is!
3. Is the investment subject to regulation and what if any protection does it provide?
Regulation varies by country and investment type. Hedge funds, for example, are less regulated than mutual funds and off-shore advisers may be subject to less stringent supervision in some countries. Regulation does not mean lower risk. A common mistake that investors make is to assume that because their investments are regulated the risks involved are reduced. Before making an investment decision, make sure you are aware of the relevant regulation and then you can fully assess the merits of the investment. It’s still possible to lose money in well-regulated markets so you need to make sure your investment decisions match your overall risk profile.
4. Trust, but verify
Ultimately, the reliability of any operation is predicated on the integrity and competence of its people. Remember that the company you choose to invest with could be overseeing your assets for many years to come so it’s important to build a trusting relationship with them. One of the best ways to do this is to adopt a “trust, but verify” mentality. Look for professionals who have achieved a mark of distinction in their career–like the Chartered Financial Analyst (CFA) designation–and professionals who abide by a Code of Ethics that requires them to place clients’ interests ahead of their own. Trust is built with consistency so looking at past experience can reveal a lot – what is their investment track record, can they provide references, are they registered with the national regulator? The more you know, the easier it is to detect a scam!
5. Don’t forget to use standard investing discipline
When the conversation turns to fraud, investors can sometimes forget that tried-and-tested investment management principles still need to be applied. Even though diversification is one of the most fundamental and enduring investment principles, many investors forget to ensure their assets are diversified widely enough. Doing so will help to limit the catastrophe associated with investment fraud but it is also more likely to provide a higher average return at lower average risk. Make sure that all investment decisions you make are aligning with your long-term financial goals and never invest in anything you don’t fully understand.
When navigating the markets, it will always be important to keep a watchful eye out for fraud. Throughout history, whenever money is involved there will tend to be an opportunity for unscrupulous people to take advantage of others. CFA Institute provides some helpful tools to educate investors on how to make informed investment decisions, so be prepared, do your homework and remember that taking steps to avoid fraud is part of a good investment strategy.