The Other Side of American Greed

January 18, 2016

Friday nights on CNBC, households all over the country are watching American Greed, the wildly popular documentary series narrated by Stacy Keach which tells the real-life stories of financial crimes and the effect on their victims. There have been episodes about Ponzi schemes, mortgage fraud, identity theft, insurance fraud and investment scams. Some of them tell truly heartbreaking stories, where the people who were victimized by the fraud seemed to be making wise decisions, only to be fooled by someone with criminal intent. In all the episodes, the message is clear:  there are hucksters and criminals who are out to steal your money — and you’d better be on guard. It’s an important message, one that we all need to hear.

Yet in all my years of watching the series, I’ve noticed that there’s a troubling back story to many of the stories that involve investment scams like Ponzi or pyramid schemes: it’s not just the con artist who’s greedy. Many of the financial crime victims had completely unrealistic expectations that they should receive out-sized returns in a very short period of time with absolutely no risk of losing money. Some appeared to be tempted by the special insider-nature of the investment: “it’s such a good deal — we’re keeping it secret but I’ll let you in on the deal.”

At best, these expectations reflect magical thinking and lack of knowledge of how the financial markets work. At worst, it’s just greed. How can we defend against greedy, bogus financial advisors – as well as our own human tendency towards wanting more and more?

Have realistic return expectations.

Every investment involves some risk of losing money. Return and risk are interrelated. Higher potential returns compensate the investor for the potential that they might lose some or all of their initial investment.With a treasury bill, the risk of loss is miniscule so the potential return is on the lower side. A venture capital investment in a start-up technology firm has a high risk that investors will lost all their money, so the potential returns are very high.

Repeat studies have shown that it is nearly impossible to beat the market averages over time, so use the long term historical market returns to set expectations for your investment portfolio. According to this chart from Ibbotson, the long term average return on large company U.S. stocks is 10.1%, and 12.2% on small company stocks. Market volatility is increasing, so the risk of seeing a big downturn in your portfolio value in any given year is greater.

In 2008 for example, large cap growth stocks in the U.S. lost 38.4% of their value. That’s why it’s so important. The conclusion: if you think you’re likely to do better than 10% per year over the long haul, you’re fooling yourself.

If it sounds too good to be true, it is.

In her new book, What Your Financial Advisor Isn’t Telling You: The Ten Essential Truths You Need to Know About Your Money, workplace financial wellness pioneer Liz Davidson counsels that if someone offers you an investment that has out-sized returns with no risk of ever losing money, run as fast as you can in the opposite direction. It’s a scam. There is no such thing as a legitimate investment that offers extremely high guaranteed returns with absolutely no risk.

Play financial self defense.

According to the U.S. Justice Department site on financial fraud, fraud often begins with, “a telephone, letter, glossy publication, or brochure offering free vacations, merchandise, investment opportunities, or services.” If you hear or read something that sounds like a really great deal, be very skeptical. If it interests you, ask a lot of questions.

Question everything before giving someone your money – including the advisor’s credentials, where the money will be held and their business history.   There is a very helpful chapter on “How to Spot a Bogus Advisor” in Davidson’s book which outlines the must-ask questions. Check out any financial advisor with FINRA and the SEC as well as your State Insurance Department, subscribe to FINRA’s The Alert Investor and check out all the great resources at the Consumer Financial Protection Bureau.

Most importantly, trust your gut. If it sounds too good to be true, it is. Don’t let your own greed set you up for a financial scam.