As the new year rolls around, some of you might be considering investing in something new or even investing for the first time. However, before you dive in and commit to any investment product there are some hard questions you should ask yourself. By doing so, you may save yourself heartache and anxiety on the road ahead.
Many self-made billionaire investors will never invest in a business they don’t understand. Why then are so many investors drawn to investing in complex instruments they can barely comprehend?
Any basic inspection of the investment industry will display a track record of complex investment products that are launched in hindsight, at the most inopportune time for investors. Many of these lose a significant amount of their investment capital, and in some cases a lot more.
The best way to navigate through the minefield of investment products is to simply base your decisions on the basis that if you don’t understand it, don’t invest in it. It’s just that simple. Before making any investment, ask yourself these five questions.
- Is the investment complex?
- Do you understand it?
- If you were a financial advisor could you explain it to your clients?
- Is it a long-term investment opportunity?
- Whose interests are being served?
The need for proper analysis into investments has been echoed by the Australian Securities and Investments Commission (ASIC) who just last year, expressed concern about the development of new products with the potential to introduce new types of complexity into products for retail investors.
These products often contained one or more of the following: derivatives, an underlying asset that is not easily valued, complicated legal structures, exit penalties or other barriers for an early exit and qualified guarantees or capital protection.
What is most alarming about these new products is that historically, many of the failed investment products in Australia contained one or more of these characteristics. Moreover, after a year of flat returns from equity markets the overriding theme is to offer returns that are uncorrelated to equity markets but still promise double digit returns.
Some of these are called absolute return funds, commonly known as “hedge funds”. Absolute return funds promise to make money, regardless of external conditions in other markets.
Investors, however, should feel the need to seriously question whether they can achieve equity-type returns in the long run with lower volatility. History shows that as alluring as this may seem, there are serious question marks against the likelihood of this happening – not to mention the very expensive fees that are charged on top.
For example, in November last year, the closure of 889 hedge funds globally against an annual average of 810 was reported.
Alarm bells should be ringing fro investors when faced with investment products offering equity-like returns with the promise of lower volatility. This notion should be a clear sign for investors to make doubly sure they understand the product in which they are investing.
Complexity is often the recipe for permanent loss of hard-earned capital and typically carries a far greater risk than investors are led to believe or expect. Be smart and do your homework. The five simple questions above can save you a lot of heartache and anxiety over the long term.
For more specific help and guidance with your own investment strategy or asset selection, please don’t hesitate to contact Our Partner - Wealth Consulting, Michael Rees-Evans CFP® in our office on 02 9299 7044 or by email at firstname.lastname@example.org
Important note: this information is based on opinions and information obtained from various sources deemed reliable. However, it is of a general nature and has been prepared without taking account of anyone’s financial situation, objectives or needs. Before making any investment decisions based on the contents you should obtain professional advice.