First, a little background. I’m the first to admit that I don’t know everything there is to know about investing. I’ve been following the stock market off and on since I was in my teens. I’ve been investing with various degrees of activity since my late 20s. I’ve had modest success. So far, I’ve come through 2008-2009 roughly breaking even. That’s out-performing the market but you invest to make money, not break even, so I consider this a pyrrhic victory. Nevertheless I feel like I’ve learned a lot over the years, to the point where I think some of it’s worth sharing.
In the back of my mind, I have a number of rules about investing. Every once in a while something happens that reminds me of those rules. Today, it was somebody following me on Twitter. I don’t get that many followers, so I have time to check profiles when I get a new one. I went to this guy’s profile, and pretty much every tweet, and his web site, were promoting some kind of seminar or something. In short, he was advertising a money-making opportunity.
I was immediately reminded of this rule: Good Investments don’t Advertise.
This is the simple way of stating the rule. Of course, there are some subtleties that need to be explained. First, it’s perfectly OK, and fully expected that good investments will advertise products that constitute their core business. Nothing is wrong with that. It’s even OK for an investment company to advertise their investment expertise. There’s nothing wrong with Charles Schwab, for example, advertising their investment services. The mere fact that they advertise is not a strike against them (but of course, you should still evaluate them based on their track record).
So. If it’s OK for a company to advertise investment services, then what do I mean about good investments not advertising?
What I’m referring to is companies that advertise themselves as investments, or that advertise financial products as opposed to financial services. You see these things in newspapers all the time: High yield investments, make money from home, etc. If you read the fine print on the high yield investments you will see that they are never FDIC insured deposits. The legitimate ones are high yield bonds, which carry a risk. The illegitimate ones are outright Ponzi schemes.
OK, so if it’s a high yield bond, aka “junk bond”, advertised in the paper, what’s wrong with that? Everything.
Think about it. These bonds can make you a lot of money under the right circumstances. What are the right circumstances? Well, for starters, diversification. If you have a large portfolio of junk bonds, a few will default but you are investing based on the odds that most won’t. The defaults will reduce your returns, but you figure that statisticly, even with a few defaults, you’ll still get an attractive yield. This is how credit cards work too, and it can be a very profitable business, if, and this is a big if, you have a large portfolio. Credit card companies have millions of customers. Junk bond funds will invest in issues from hundreds of companies. That ad in the paper is asking you to invest in one company, that’s bad enough but what’s worse is they’re advertising. Why is that so bad?
Well, with all the junk bond issues out there, you must figure that most of them aren’t advertised in your local paper. Do you think that a bond that has to advertise in your local paper is better or worse than one that doesn’t? How do fund managers usually find out about junk bond issues? Do you think they pick up the Podunk Gazette and pull the trigger there? Something tells me they don’t. The ad could be saying anything, but what it tells me is “We couldn’t sell these through the usual channels, so we’re trying to sell them here”.
OK, maybe some furtune 500 companies might advertise bond issues in the Wall St. Journal. They will be accompanied by a little fine print and pointers on how to find out more about the terms of the bonds. The same thing happens with IPOs, or at least it did the last time I picked up a printed copy of the WSJ. This is perfectly legitimate, so the rule isn’t etched in stone. It’s a bit more nuanced than a one-liner; but I think you get the drift here. At least, I hope you do.
Sometimes investments that advertise are people starting small businesses. We’ve all heard the story of how Sam Walton went to friends and neighbors to raise money for Wal Mart, and how all those folks became zillionaires. OK, fair enough. Nevermind the fact that there are a lot of small towns and only one Wal Mart. If your friend or neighbor comes around with such an opportunity, don’t dismiss it out of hand. Consider their talents. You probably know them. You may have been thinking, “this guy should go into business”. You might not end up a zillionaire, but you might end up owning a piece of a good solid business. There’s nothing wrong with that. Just make sure you understand the risk.
Now let’s consider a guy who is advertising such an opportunity on Craigslist or worse yet, spamming you from out of nowhere. This guy must have had friends. He must have had family. He has a local bank. Did he go to them first and get turned down? Did he decide to go to perfect strangers on the ‘net first, before going through normal channels? Either way, it raises red flags. If he got turned down by the first parties, it says something about his character or ability. If he went to strangers first, that says something about his judgement. Yeah, sure, it’s possible that the guy on Craigslist who need $100k and wants to partner with you to buy real estate is not going to cause you a lot of heartache; but why take chances? If you really know your beans, if you’ve done real estate deals before, if you not only know what a “hard money lender” is but have actually done several hard money deals, then answering the ad might make sense. Otherwise, forget about it.
