Thursday, 19 November 2009

How to Spot and Avoid Investing Scams

Notorious cases like Bernie Madoff in the USA and Earl Jones in Canada highlight the necessity for vigilance to avoid losing one's hard-earned money to investing scam and fraud operators. The danger is not confined to the newbie investor. Indeed, as the Madoff and Jones cases illustrate, experienced and knowledgeable investors are just as susceptible. Read this cautionary tale Why we keep falling for scams in the Wall Street by Stephen Greenspan, a university professor psychologist specialising in gullibility who was one of the victims of the Madoff rip-off. In fact, a research study by the University of Exeter for the Office of Fair Trading in the UK found that "... scam victims often have better than average background knowledge in the area of the scam content"!

The recent investing environment, which has seen a huge slump in returns in 2008, may make some especially anxious to jump on opportunities that promise large returns in a short time. People who are approaching or who have just started retirement may be particularly at risk if they have a big shortfall in funds needed for their retirement years since they may not have other means to make up the deficit.

How then can one spot a scam and more important, avoid being taken in?

Scam Spotting - don't take it from this blogger whom you do not really know, take it from known trustworthy verifiable sources (get the hint?!), which have excellent guides to scams like Ponzi and Pyramid schemes, or those involving legitimate-sounding investments such as exempt securities, forex, offshore investments, prime bank notes, gold and silver mines, oil wells, coins and precious metals, RRSP or Locked-in RSP tax-free withdrawal.

The sources below also review typical inducements and techniques used by the fraudsters: no-risk and high return, insider tips and get-in-now-before-it's-too-late, high pressure sales, investment seminars (such events are not necessarily fraud vehicles), invitations to invest with the smart/expert money, pressure to do like your friends/social group/church (especially odious IMHO) and a need for secrecy.
How to Avoid and Resist Being Taken
Though the above documents and websites contain many useful tips to follow, antidotes also need to consider a few surprising findings in the Exeter study: scam victims report that they analyzed scam content more than non-victims; scam victims are more likely to be taken in again for another scam and victims in general are not poor decision makers and are often successful in their professional or business field. Victims often have an inkling and a gut feeling that things are not right or as promised - but they go ahead anyway!

The reason according to psychiatrist David Krueger in his recent book The Secret Language of Money is that scams only work with our willing participation. That's due to our emotional vulnerabilities. Our fantasies, our need to be special, to appear knowledgeable/ not look stupid, to belong, to cooperate and obey legitimate authority, to be taken care of, our susceptibility to impulse and our desire to put one over sabotage our judgement by allowing the emotional parts of our brain to overwhelm the rational part.

Suggested tactics:
  • trust your gut instinct, it's usually right
  • ask yourself what you could lose, not what you could gain; ask what could go wrong
  • ask yourself why you are the chosen lucky one to participate in this investment
  • if this is such a sure-fire scheme, why isn't everyone else doing it?
  • ask yourself if the scheme is too good to be true
  • always give yourself a time gap before acting; make it a rule to sleep on it
  • talk to someone else you trust who is neutral, not familiar or involved with the idea and run it by them
  • question the authority and genuineness of the person contacting you - how do I know you are who you say you are? - invoke your sceptical self
  • become a little paranoid because the assumption that you are too smart or informed to be conned can be an Achilles heel
  • when in a times of personal crisis, such as divorce, job loss, death in the family or economic downturn, vulnerability to the urge to have someone take care of you is greater - be aware of that, tell yourself that and confront the feeling as the illusion it is
Having a good head on your shoulders for investing means both being well informed and rational in judging facts, and it also means recognizing and properly harnessing your emotions.

Disclaimer: this post is my opinion only and should not be construed as investment advice or recommendations.

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