Business & Real Estate

How to exercise due diligence to make the right financial decisions

I heard a radio commercial the other morning while commuting to work. It was from some real estate firm that promised to teach me how to buy, hold and sell properties with no money down and no risk. Imagine that: No risk! How could anyone turn down such an offer?

  It can be difficult to exercise the due diligence necessary to make good investment decisions. It is easier, however, to avoid making bad ones by watching out for questionable claims that suggest a questionable investment. Following are a few from my list.

No risk

It is a basic tenet of investing that the higher the return you expect, the more risk you must be willing to accept. Imagine two investments, one returning 5 percent with no risk (that is, guaranteed) and another returning 5 percent with a 20 percent chance that you could receive less.

Who would ever buy the latter? The market would force the second investment provider to increase the return to compensate for the additional risk. This holds true for any type of investment (real estate, stocks, gold, CDs, even works of art). The exceptions are U.S. Treasury bills, notes and bonds, which are backed by the full faith and credit of the U.S. government and as such are considered risk-free (at least for now).

To be blunt, if you encounter the words “no risk” as part of a pitch or recommendation for an investment, it’s a lie. Would you really consider investing in something that starts out with a false claim?

No market risk

A variant of “no risk” is “no market risk.” This is commonly used by an investment offer that does not involve the capital markets, such as real estate or accounts receivables. Although it could be true, if the promotion focuses on the market risk you will be avoiding without addressing all of the nonmarket risks you will be incurring, at best it’s misleading.

Once again, I’d recommend adding it to your wastebasket collection.

Proprietary

Many smaller investment firms invoke the “proprietary” claim for mutual funds or investment management services that directly or indirectly promise either to get you higher returns or to protect you from some amount of losses. The promotion usually involves some form of superior market timing or investment selection based on a “proprietary” methodology.

It may in fact be proprietary, but that doesn’t mean it works. If the promoter can’t (or won’t) explain the methodology to you in a way that you can understand, the investment really is nothing more than a gamble.

Secret

A variant of “proprietary,” you’ll often see the word “secret” in promotions for newsletters or training events: “Learn Warren Buffett’s secret for successful investing!”

Putting aside the nonsensical implica-tion that there are investment secrets known only to a small handful of ultra-rich individuals, consider the logic of the claim. If the “secret” is being

promoted via public media, how could it possibly remain a secret? And once it’s out, wouldn’t it lose all benefit because everyone would now be doing it? Besides, just because Buffett makes money doing it – assuming that he really does – doesn’t mean you will.

Proven

“Proven” is nothing more than using past history to justify and promote future returns. Just because an investment did well over the past 10 years tells us nothing about what it will do over the next 10. Read any of Nassim Taleb’s books (for example, “Fooled by Randomness”) and you’ll get an understanding of how luck and randomness play a much greater part in investing success than most investment promoters would admit.

The bottom line: Be skeptical of investment promotions. Los Altos resident Artie Green is a certified financial planner and principal at Cognizant Wealth Advisors. For more information, call 209-4062 or email This email address is being protected from spambots. You need JavaScript enabled to view it..

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