How to Spot Investment Warning Signs and Red Flags

Summary

• Every investment carries risk, but some warning signs can point to an investment that may not fit your goals, timeline or comfort with risk.
• Be cautious about high-pressure sales tactics, promises of guaranteed returns and requests for sensitive financial information.
• Understand how an investment works, what it costs and how easily you can access your money before committing.
• Complex, speculative or illiquid investments may require additional research and careful consideration.
• Give yourself time to evaluate an opportunity and consider getting another qualified perspective before making a decision.

Investing involves risk, but that does not mean every investment carries the same kind or level of risk. Before committing your money, take time to understand what you are buying, what it may cost and whether it fits your financial goals.

Some warning signs are easy to recognize. Others may be hidden behind complicated terms, an attractive sales pitch or pressure to act quickly. Knowing what to look for can help you make a more informed decision.

Be Cautious With “Free” Investment Advice

A free meal, seminar or consultation can sound harmless, but it may also come with a high-pressure sales pitch. Legitimate financial products and planning services can be promoted in these settings, so the setting alone does not determine whether an opportunity is appropriate.

What matters is whether you have enough time and information to evaluate the offer. Avoid making a financial commitment simply because an opportunity is presented as limited-time or exclusive.

Do not share sensitive personal or financial information, such as your Social Security number or bank account balances, with someone you do not know or trust. If an investment interests you, take time to review it after the presentation. You may also want to seek a referral from someone you trust or discuss the opportunity with another broker or adviser.

Understand Complicated or Speculative Investments

An unfamiliar investment is not automatically a bad investment. However, complexity can make it harder to understand the risks, costs and potential outcomes.

OTC stocks

Over-the-counter, or OTC, stocks are securities that are not listed on a major stock exchange such as the New York Stock Exchange or Nasdaq. Instead, they are traded through broker-dealer networks.

Some OTC companies report information to the Securities and Exchange Commission, while others may provide less public information. That can make it harder for investors to evaluate the company and may increase the risk of fraud or loss.

Penny stocks

Penny stocks are generally low-priced stocks, often trading for less than $5 per share. Their low price can make them appear accessible, but many are highly speculative and volatile.

Before investing, consider whether you understand the company, the market for its shares and the possibility of losing some or all of your investment.

Review Investment Fees

Investment fees can reduce your returns over time. Before opening an account or purchasing an investment, understand the fees you may pay and when they apply.

Common investment fees

Brokerage fees: These may include annual fees, inactivity fees, research or data subscriptions, trading platform fees, paper statement fees, and account closing or transfer fees.

Stock trading fees: Some transactions may include commissions or other charges for buying or selling stocks, options or exchange-traded funds.

Mutual fund transaction fees: A brokerage fee that may be charged when you buy or sell certain mutual funds.

Expense ratios: Annual operating expenses charged by mutual funds, index funds and exchange-traded funds as a percentage of assets.

Sales loads: Sales charges or commissions associated with certain mutual funds.

Management or advisory fees: Fees commonly calculated as a percentage of assets under management.

401(k) fees: Administrative or investment-related fees associated with maintaining a retirement plan.

Review the fee information provided by a broker or investment provider before opening an account or making a transaction. Small recurring costs can add up over a long investment horizon.

Consider Liquidity Before You Invest

Liquidity describes how easily an investment can be converted to cash. An investment with low liquidity may be difficult to sell when you need the money.

Real estate limited partnerships are one example. Investors pool money to invest in real estate, but interests in these partnerships generally are not publicly traded. Selling your interest may require finding a buyer, and the partnership agreement may limit when or whether a sale is permitted.

Before investing, understand how and when you can access your money and whether restrictions or penalties may apply.

Understand the Terms of Callable CDs

Callable certificates of deposit differ from traditional CDs. They may have long maturities, and early withdrawals can carry penalties. The issuing financial institution may also have the right to redeem, or “call,” the CD before its stated maturity date.

If that happens, you may need to reinvest the money sooner than expected, potentially at a different interest rate. Review the CD’s terms carefully, including maturity, call provisions, withdrawal penalties and deposit insurance coverage.

Approach Derivatives With Care

Futures and options contracts can be highly volatile and may require close monitoring. Depending on the product and strategy, losses can be substantial.

If you are unfamiliar with derivatives, make sure you understand how the investment works, the potential losses and the obligations involved before deciding whether it belongs in your financial plan.

Watch for Investment Scams and Deceptive Offers

Investment pitches can arrive through phone calls, emails, letters, advertisements, social media or online discussion groups. Treat unsolicited opportunities cautiously, especially when someone promises guaranteed returns or claims an investment carries no risk.

Every investment involves some degree of risk. Pressure to act immediately, claims that an opportunity cannot lose and requests for sensitive financial information are reasons to slow down and investigate further.

Avoid discussing your financial situation with strangers. Take time to verify who you are dealing with and understand the investment before providing money or personal information.

Give Yourself Time to Make the Decision

A sound investment decision starts with understanding the opportunity. Before committing your money, ask what you are buying, what risks you are taking, what fees apply and when you can access your funds.

You do not have to make an investment decision on someone else’s timeline. Taking time to review the details and seek another qualified perspective can help you decide whether an investment fits your goals and circumstances.