Learn from others to help avoid hard losses

There are two ways of learning: You can be taught how to do something correctly, or you can be shown the consequences of doing it wrong. In the world of investments, learning from others’ mistakes is cheaper.

Investment scams continue to surface, often hurting those with only modest nest eggs. Most of these schemes involved high-risk finance to property ventures, some involving speculative residential projects. Yet, these investments were often promoted as safe, secure and bank-like. In some cases, the promoters of the schemes extracted high fees (as much as 5 percent) from the vehicles, and engineered related-party transactions that cost the elderly clients millions, without giving them any say in the matter.

Unfortunately, investors often had their entire life savings in a single investment product, which meant there was no safeguard when things went wrong. On top of all this, the schemes were promoted by financial “advisers,” who earned commissions on their sales. The wonder is that these dubious schemes continue to fleece thousands of people five years after the financial crisis exposed the folly of structured and highly conflicted mortgage finance vehicles and securities firms masquerading as banks.

One heartbreaking example was a widow with an autistic son who lost $330,000 in compensation from the death of her husband after she was advised to put the money into a fund linked to a finance company that later failed. The woman is now unable to afford the special education the boy needs and has called on her in-laws to provide emergency child care while she works full time.

The recent new regulations may improve disclosure to investors and remove conflicts of interest around advice, but they are too late to help those hurt by these disasters.

So, how can individual investors protect themselves? First, understand risk and return. If someone is offering a “low-risk” investment with a regular return well above the risk-free rate, alarm bells should go off. Return doesn’t come without risk, but not all risks are worth taking. Be sure you understand any investment.

Second, diversify. It is the primary directive for any investor. Sinking your life savings into a single property scheme or mortgage fund is not diversification. That is taking a massive, speculative bet on a single asset.

A better strategy is to spread your risk across a range of asset classes: domestic and developed market equities, emerging markets, local and global bonds, listed property and cash. And within each of those asset classes, you should diversify as much as possible.

Third, fees matter. The difference made by a 1 percent, 2 percent or 3 percent fee can run into hundreds of thousands of dollars over the years. Time after time, I see the rewards in these heavily marketed schemes going not to the end investors but to the promoters.

Finally, and most importantly, get truly independent advice. That means avoiding the recommendations of someone who is receiving a financial or other incentive from the provider whose product he is promoting.

A good adviser will work for you. That means understanding your risk attitude, your situation and your investment and lifestyle goals. It means structuring a diversified portfolio that reflects your needs, not what a product provider has to sell.

Ordinary investors can’t control markets or the economy, but they can learn from these lessons and steer clear of anything that smells of conflicted advice, promises of high returns and low risk, lack of diversification, high fees and slick marketing.

If we don’t learn these lessons from the experiences of others, we risk having them taught to us directly. And in those cases, the tuition bills can be substantial.

Mark Sievers, president of Epsilon Financial Group, is a certified financial planner with a master’s in business administration from UC Berkeley. Contact him at mark@wealthmatters.com.