How to Avoid Crooks when Investing in Shares

The United States securities industry is one of the most carefully regulated in the world. The SEC, the U.S. Securities and Exchange Commission, joins state securities regulators in watching over this vital industry. The SIPC, of course, insures investors against loss if member brokers go out of business, and each stock exchange regulates the companies that trade upon them.

Still, things happen. Investors may suddenly hear, for example, that a respected asset manager is describing his business as a giant
Ponzi scheme. (A Ponzi scheme is one in which the money invested by new clients is used to pay dividends to old clients.) It can make anyone wonder how they can protect themselves.

One important step in avoiding crooks is to resist your own greed. Investors can get sucked into sketchy investment schemes because they are promised outrageous rewards. Reward is always tied to risk. Diversification can mollify risk a bit, but, if you are making a huge return, you are, by definition, taking a huge risk.

Some areas of the investment field are inherently more risky. If you buy penny stocks, stocks that sell for under $10 or so and probably do not trade on any exchange, you are taking an outsize risk. Never buy anything from someone you met over the phone either, even if he says he is your brother’s best friend. Just tell him you never buy anything over the phone. It won’t shock him; he’s heard it often.

When you have done your research and decided to invest, be certain you grasp how the investment works. Magic has no place in the investment world. Ask questions until you understand exactly how the return on your investment is being earned. Ask yourself if it seems reasonable for that kind of investment to bring that reward.

Be skeptical. If someone is making a steady 2% a month in a market that has been going steadily downward, this should raise red flags. The money you have invested should, by nature, be earning just about the same returns as the average for that type of investment everywhere. If your returns are outside of the norm, it should make you wonder why.

If you want honesty in the business world, be honest yourself. This should go without saying, except that securities laws are so complicated and arcane that it is easy to flout them without knowing it. Never act on inside information. Never pass on what appears to be inside information. It may be a cold tip anyway, by the time it gets to you.

Andrew Carnegie said to put all your eggs in one basket and then watch the basket. It certainly worked for him. Unless you want to spend every minute of your day watching though, a good defense in an uncertain world is diversification. Spread multiple nest eggs through a variety of baskets, in a variety of places, and no one bad egg will be able to do you any meaningful harm.

The vast majority of people in any field are honest and well intentioned. To protect yourself from the few others, you only need to use caution and good sense.