Many people in the investment field think they know what they are talking about. The truth is – they don’t. It’s not surprising to find that most people don’t know what an “investment” actually is, so they are easily confused by the “finance speak” and high-gloss brochures passed out by some really nice guy in a suit. Let’s look at some specific definitions that may help you understand the game you’re getting involved in.
Let’s go over this one definition (I have abridged Merriam- Webster’s full definition to relate it to the financial arena and make it more clear) :
v. invest·ed, in·vest·ing, in·vests v.tr
2. To make investments or an investment: invest in real estate.
[From Italian investire and from French investir, both from Latin investre, to clothe, surround: in-,in; see in- + vestre, to clothe (from vestis, clothes; see wes in Indo-European roots).]
From Wikipedia: “Investment has different meanings in finance and economics. Finance investment is putting money into something with the expectation of gain that upon thorough analysis, has a high degree of security for the principal amount, as well as security of return, within an expected period of time. In contrast, putting money into something with an expectation of gain without thorough analysis, without security of principal, and without security of return is speculation or gambling. As such, those shareholders who fail to thoroughly analyze their stock purchases, such as owners of mutual funds, could well be called speculators.
“To avoid speculation, an investment must be either directly backed by the pledge of sufficient collateral or insured by sufficient assets pledged by a third party. A thoroughly analyzed loan of money backed by collateral with greater immediate value than the loan amount may be considered an investment. A financial instrument that is insured by the pledge of assets from a third party, such as a deposit in a financial institution insured by a government agency, may be considered an investment.
Examples of these agencies include, in the United States, the Securities Investor Protection Corporation, Federal Deposit Insurance Corporation, or National Credit Union Administration, or in Canada, the Canada Deposit Insurance Corporation.
“Promoters of and news sources that report on speculative financial transactions, such as stocks, mutual funds, real estate, oil and gas leases, commodities, and futures often inaccurately or misleadingly describe speculative schemes as investment.
Investment: thorough analysis and security. Speculation: analysis and some risk. Gambling: lack of analysis and lack of safety.”
Thus, based on the above definitions, it is only an investment if after a thorough analysis there is a high degree of certainty that your principal is secure and that you will actually receive the expected return. Anything less is speculation or gambling. Ninety-nine percent of the “investments” most people get involved in are, in fact, speculation or gambling. They will put a chunk of their life savings in some deal solely because someone they trust said that specific deal was hot. They “invest” with not much more research than that. It is important to name highly speculative deals exactly and not lump them in with safe, conservative investments, to avoid giving them an air of safety they do not deserve. Mislabeled speculation gives investment a bad name.
How can it be that a seemingly promising deal can flop so miserably? After looking over many failed “investments,” the most common mistake is believing that it is an investment and not a gamble per the above definitions. Somehow, “this one is different from all the rest” without careful assessment of all the facts. Far too many investors refuse to do the analysis to determine if it’s an investment or a gamble. They just cut out the work and take someone’s word that THIS really is an investment – this time. This is, of course, usually fatal to your capital.
As an example, in May of 2011 I had a long discussion with a client who was being promoted an investment that promised a 17X return in just a matter of weeks. It was being promoted by people with significant experience and good reputations. Who could possibly pass it up? It was virtually guaranteed!
I actually laughed out loud when I was told about it. My client was slightly offended at my response, so I had to agree to take a careful look at it to make up for my crass behavior. They were ready to invest nearly a million dollars and the prospect of losing out on a $15,000,000 return was just too much to let it pass by without so much as a sniff by me.
I looked at it carefully as agreed, and it was garbage of the highest degree. I refused to let my client near it. One of the trusted sources, upon careful investigation, was found to have had a terrible reputation for rip-off investments and a long history of failed deals.
The promoters somehow missed that.
The details that proved it was bogus were right in the very documents I was sent to convince me it was real.
I shared these with other professionals and they all had the same opinion as me: “Stop! Red alert!” “DANGER WILL ROBINSON, DANGER!”
As of today (more than 2 years later), one of the promoters is still expecting and professing their payout is days away! They truly believe it is still coming, and if I say otherwise, they consider me the nutcase. If I told you more you’d laugh, too.
I tried my best to get it shut down immediately and show them some facts, but they had already cornered enough “investors” who had swallowed the bait whole. Well over two million dollars went down the drain.
Interestingly, one investor (who was a seasoned investor) in this deal, whom I did not know, called me about nine months later because he had heard I researched the deal and had come out against it. He wanted to know what I knew about it. He confided in me that he went into it without knowing anything about the deal, that in fact he was refused any details on what the investment was and had to take it on the word of the promoters.
He was shocked to hear what the deal was all about when I told him. I was even more shocked that he put such a large amount of cash in with no more research than “trust me” from a reliable source who didn’t have the cash to actually guarantee the deal.
There is an important lesson here. ANYONE, regardless of experience and education, who skips taking a good hard look at all the important details, significantly increases the likelihood they will lose their money. Too often, anyone with a good story and an honest face is pushed to the front of the line. I think most people don’t look because they have no idea what to look for and consequently just accept the story.
This brings us to another important factor when investing, greed.
Like what you’ve read? Subscribe to our blog, you’ll be the first to hear about our updates. Next week the Due Diligence Series on Investments will continue. Find out how greed plays a distinct part in investment mistakes and how to detect and avoid it.
Subscribe & Follow