Warning Signs of Bad Investments

The act of accumulating and investing wealth is a dangerous proposition for the Christian.  The hardest part of the process isn’t picking the right investments, but rather, guarding our hearts from the love of money.  We need to always be aware of the desires of our heart, especially when money is involved.  There’s a point when our motive for investing can go from being a good steward and making the most of what we’ve been given for God’s glory to greed and the desire to get rich for our own glory.

Solomon wrote of this danger in Ecclesiastes 5:13-14:

“There is another serious problem I have seen under the sun. Hoarding riches harms the saver.  Money is put into risky investments that turn sour, and everything is lost. In the end, there is nothing left to pass on to one’s children.”  [NLT]

In this verse, we see the danger of hoarding and how it actually harms the saver.  I’ve already covered hoarding at length, which you can read here.  Hoarding and greed go hand in hand and both are a form of idolatry.  The hoarder desires money more than God and so he wants more of it and is always looking for ways to get it quickly.  That takes us to the second part of this verse, the warning against risky investments that eventually turn sour and everything is lost.  Those bad investments can be very destructive, not only to your balance sheet, but also to your family.  I’ve seen families torn apart as a result of investments gone bad.

Because of their destructive nature, I can’t overemphasize the importance of avoiding bad investments.  It’s wise to try to earn a return on your money, but making investment choices out of the desire to get rich is totally different.  As you’ll see later, the desire to get rich is one of the key reasons people make bad investments and those involved in the schemes know it.

Investment Red Flags

By working with clients and having been shown all kinds of investments through the years, I’ve had the benefit of seeing and hearing about a lot of bad ones.  The following list of warning signs is not exhaustive or definitive, but it should give you things to consider the next time you find a supposedly amazing investment opportunity.  If you find yourself considering an investment that has one or more of these traits, I would suggest taking the time to do more research and seek wise counsel.

1.  The No-Lose Investment:  Big Upside, Little Risk – It’s the classic salesman tactic.  Get the buyer excited enough and they’ll buy whatever you’re selling.  As the potential buyer, remember that a salesman doesn’t typically qualify as wise counsel when their sole motivation is to sell you what they have to offer.  As an investor, it will serve you well to play the skeptic.  Look at the investment from the perspective of what could go wrong.  In the end, you need to have all your questions answered and be comfortable with the downside risks of any investment you make.

2.  The Name Dropper:  You Can be the Next Warren Buffet – Another marketing tactic is to get you to visualize a grand dream.  I often see this done by subtly dropping names that will make you dream big.  I used to hear people talk about investments being the next Warren Buffet or Microsoft.  It’s since become the next Google or Apple.  Regardless of the name being dropped, be aware of this tactic and let the warning bells ring when you hear them.

3.  The Short Fuse:  Quick Decision Required – The requirement of a quick decision should be an obvious warning sign.  It’s the perfect way to keep people from doing research.  This takes us back to our fundamental rule for investing, don’t invest in things you don’t understand.  If there’s not enough time to do your research and understand the investment, don’t do it.

4.  Easy Money:  You Don’t Need to Work – The biblical model shows a direct relationship between work and money.  If we’re presented with an opportunity to make money without work being involved, we should be skeptical.  This is a common tactic that has been used by pyramid and network marketing schemes over the years.  They get you excited about an opportunity to make money in a business venture that requires you to do little or no work and promise that you’ll be able to sit back and watch the money roll in.

5.  The Holy Grail:  Here’s the Secret to Wealth – Some investments try to lure people by claiming to have secret information of the wealthy or perhaps even secrets that the wealthy haven’t even discovered yet.  I often see infomercials and internet ads making these claims.  In the end, the only people getting rich are the ones taking money from the people buying this false information.

6.  The Nice Guy:  I Just Want to Help You – Some deals sound so great that you start to wonder why they wouldn’t keep it all for themselves.  I’ve heard some salesmen claim that they just want to help the little guy get rich.  It’s amazing how many people buy that line.  It’s probably because the idea isn’t so great and the smarter people and institutions with deep pockets have wisely turned them down.

7.  The Dream Maker:  You Can be Rich – An appeal to greed is the primary warning sign.  As Christians, we need to be aware of the motivations of our heart.  When we get excited about an investment opportunity, we need to ask ourselves if we’re being motivated by a desire to be good stewards or by a desire to get rich.  Unfortunately, when bad investments come knocking, they often appeal to our desire to get rich.

Proverbs 28:20 – “A faithful person will be richly blessed, but one eager to get rich will not go unpunished.”  [NIV]

Proverbs 28:22 – “Greedy people try to get rich quick but don’t realize they’re headed for poverty.”  [NLT]

As I mentioned above, investment scams are notorious for talking about huge potential gains.  I once saw a scam that promised to double investor money every 3 months.  That promise was so big that people were willing to risk their money simply out of the fear that they might miss out on something huge.  It created a herd mentality where each person that bought in helped convince the next.  It didn’t matter that the “investment” made no logical sense.  Behavior wasn’t rational, and even the logical impossibility of it all didn’t matter.  Math alone would show someone that a $1,000 investment at that rate would grow to over $500 Trillion in just 10 years.  It was impossible, but nobody cared because they didn’t want to miss out on the possibility.  As expected, the ending was tragic for everyone.

The old saying “If it sounds too good to be true, it probably is” stands the test of time.  Still, a lot of smart people will eventually believe they found an exception.

8.  No Third-Party Bank:  A Lack of Accountability – I’ll call this the Bernie Madoff warning sign.  In his investment scam that turned out to be nothing but a big Ponzi scheme, he served as the bank and the statement creator.  Had investor money been held at a separate bank or trust company, they would’ve been the ones creating the statements for clients.  Instead, Madoff was able to generate false statements that made it look like investors’ accounts were making money while everything was actually falling apart.  The truth didn’t come out until it was too late.

It’s good for investments to be regulated and have oversight.  A lot of scams fall outside of those typical investment regulations that bring transparency.

Other Things to Consider

There are other investment characteristics that can be warning signs to a lesser degree than the ones listed above.  Most of these just add to the degree of risk taken on by the investor.

Lack of Liquidity – Liquidity is the ability to turn an investment back into cash.  When liquidity is limited, risk is increased.  When you are unable to get your money out of an investment when you want, there is a greater chance of loss.

The only true value of an investment is what someone else is willing to pay you for it, regardless of what your statement may say.  It may be hard to find a buyer when things aren’t going well.  Some illiquid investments, like private equity (stocks not traded on a public market), end up being all-or-nothing investments because they either succeed or lose everything trying.

Personal Commitment – When making an investment, consider the time and stress involved in that investment.  A good example is rental real estate.  While there is potentially good money to be made, there is also a time commitment and stress involved if you plan to manage the property on your own.  You can hire that to be done by someone else, but that will eat into your profits.  Be careful to not let an investment affect your marriage or family life.

Surrender Charges – Perhaps your investment is liquid, but it comes at the cost of surrender fees if you want your money back.  I’m really not a fan of surrender charges because I like flexibility and surrender charges reduce my flexibility of changing investments.  Surrender charges are often placed on investments that paid a commission to a sales agent as a way to recoup those costs if you decide to move your money.

Debt – It’s a common practice to try to build wealth faster by using borrowed money.  That can work when things go well, but it also increases risk.  Proverbs 22:7 says, “the borrower is the slave of the lender.”  Just like a slave, the borrower must obey the orders of the lender.  When things are not going well, the investor can be forced to make decisions they wouldn’t otherwise make and often at the worst times.  If you think it hurts to lose money in an investment, imagine losing someone else’s money and then being forced to pay them back after the opportunity for gain is gone.

Conclusion

In a world full of sinners, there is no shortage of bad investments and even malicious investments that are designed to take your money.  As God’s stewards, we need to be able to discern the difference between a good and bad opportunity.  If you do your research and you’re still not sure, sit it out and watch from the sidelines.  It can be a great learning opportunity since you’re already familiar with the investment and you can see things play out.  You may be relieved in the end or you may see a good investment blossom and have time to get in at a later date once you’ve become comfortable.  In either case, you will have made the wise decision at the time.  If you happen to miss out on a whopper, find enjoyment in telling the story of the one that got away.  In the end, it’s better to miss out on a great investment than it is to be involved in a bad one.

Brad Graber, CFP® has been working with clients on personal financial planning and investment issues since 1996.  He invests his time mentoring and educating individuals on ways to be better stewards of the resources God has entrusted to them.

***Disclaimers:  The information contained in this article is general in nature, is provided for informational purposes only, and should not be construed as investment advice.  I cannot guarantee that all information is accurate, complete, or timely.  Any performance related material is for information purposes only.  Past performance is no indication of future results and should not be used for making investment decisions.  Performance data was provided by Morningstar.  The information in this article should not be construed as investment advice or a recommendation of any particular investment.  Please seek out professional investment advice before investing.