Caveat EmptorSubmitted by Trace Wealth Advisors on July 9th, 2019
A client recently came to me with an “innovative investment opportunity” that had been offered to him by a friend. The friend told him that he had met a fund manager while on a cruise (red flag #1) and he told him of an algorithm he had created (red flag #2) that could predict the direction of the US stock market one to two weeks in advance (I just ran out of red flags but this is one too).
I begrudgingly read the offering memorandum (which apparently none of the existing investors bothered to do) and determined that an excel spreadsheet populated with numbers based on quasi-technical analysis of the S&P 500 is neither an innovative investment opportunity nor an algorithm but I digress...
It’s actually pretty rare that something comes along in finance that hasn’t been thought of before so here are 10 quick rules to abide by when looking at a new potential investment:
Rule #1: Look for the hidden fees. They’re usually in there somewhere and they can be hard to find. I remember years ago being offered a private equity investment that billed itself as having “no annual management fee”...except for the 2% “annual administrative fee” paid to the GP’s parent company.
Rule #2: Look for the conflicts. They’re always there. I don’t care who it is or what they’re selling, everyone has a conflict.
Rule #3: Determine what’s in it for them beyond just the fee. Prestige within their firm, a free trip for making their sales quota, their next promotion...there are often ulterior motives.
Rule #4: This time isn’t different.
Rule #5: There is no such thing as a free lunch. The same applies to dinner.
Rule #6: A decent investment is 50% good idea, 30% marketing, and 20% luck. A great investment is 70% good idea, 10% marketing, and the same 20% luck. Don’t ever underestimate the role of good fortune.
Rule #7: The best 10 years for any backtest is the last 10 years. Doesn’t matter when or what the last 10 years looked like. It never fails...and people fall for it every time.
Rule #8: Mean reversion is like gravity for investments and yet it amazes people every time.
Rule #9: If the salesperson has a car that costs more than your total college tuition (adjusted for inflation), walk away.
Rule #10: If the salesperson has a watch that costs more than your first car (adjusted for inflation), RUN away.