Special report: When is an investment opportunity too good to be true? 5 questions to spot the red flags

We are often asked by clients about investment opportunities they might have received from a friend, a special offer or even directly from a company promising high guaranteed returns (over 6% fixed per year), low/no fees or risk and easy access to their money.

On the face of it, these might sound like the perfect investment for lots of investors, and they would be, if they were genuine. Unfortunately, many similar offers are either extremely high risk, loosely regulated, if at all or just outright scams.

With the arrival of digital currencies like Bitcoin into mainstream finance, financial authorities have tried to keep up, creating legislation like the EMD (Electronic Money Directive) in Europe to regulate the operations of cryptocurrencies and digital broker apps. As with any new market, the pace of change often outruns the pace of understanding and regulation, leading to loopholes and exploitation.

If a stranger approached you in the street and suggested you give them $10,000 right then and there, on the understanding that they will look after your money pay you 10% interest every year and then give you back the cash in 5 years, you would probably laugh at them or call the police, yet this is the reality of many ‘offers’ seen today on the internet. Unscrupulous individuals exploit the hype and opacity of online/app-based trading, blockchain technology, peer-to-peer finance and other fintech-buzzwords to cheat unsuspecting investors out of their hard-earned money.

Not all fintech is bad. The financial services industry as a whole is moving more and more towards a globally-connected, technology-driven model and crypto-currencies are no longer the preserve of adventurous entrepreneurs and programming gurus. So how can you tell if an investment is the next big thing or a hidden trap? Here are some key things to watch out for if you see an ‘investment opportunity’ that could help you spot the difference between a unicorn and a dead horse in a spiky hat.

1. Are you hearing the whole story?

Don’t just read the glowingly positive online feedback and never trust the overall rating. Review farming is a very real problem these days and often a shady company will pay people to write positive reviews to bump up their rating. If a company receives lots of similar, short and very positive reviews on a particular day and then nothing for a while before another chunk of ‘happy customers’ all chime in at once, think twice. Look at the bad feedback first and work your way up.
If a friend, colleague or acquaintance recommended the investment to you, check with them if they are receiving an incentive for you to join or if they have managed to actually get their money back, rather than just seeing early results. Many pyramid schemes rely on generating good feedback and word of mouth with commissions or early positive results in order to attract more and bigger investors quickly before the scheme collapses and only the organisers make any money.

2. Where is your money?

When it comes to investments, it is sometimes difficult to see where your money is actually going. Especially if you can see a ‘balance’ onscreen or through an app it can seem like your money is safe, even if it is not. Particularly with e-finance and fintech, your investment value is only as safe as the company that provides it. For banks, regulated funds or shares there are clear and strict regulations governing who can hold your money and how, along with what they are permitted to do with your money while they are looking after it. For many fintech companies, such as crypto wallet providers, the rules become much more hazy. One of the key selling points of cryptocurrencies is the decentralisation that comes with a blockchain organisation. However, if you use an online ‘wallet’ or crypto broker, you give up that security by exposing yourself to the risk of whoever is storing and trading your coins.

3. What’s in the engine room?

If an investment promises surprisingly high returns, ask where those come from. Also don’t just consider the number that is being offered to you, think about how the provider is making a profit, too. Imagine that someone offers you a fixed interest rate of 7%, with a ‘sign-now-bonus’ of an extra 1%. That’s 8% return per year, which sounds great. Even better, the same company is offering you a 5% ‘commission’ if you convince your friends or others to invest their money too. Adding these up, it means that for the company to just break-even after paying out the returns and commissions to you and your friends, they need to be consistently returning over 13% per year. Where are these numbers coming from? Any reputable and genuine investment provider will be more than happy to let you know what drives their investment strategy. It’s as much a badge of honour to show how effective their model is as it is a requirement to show that success come from legitimate and legal operations. If an investment claims to be making stellar returns but won’t tell you exactly where from, steer well clear. At best, it could be a scam; At worst, a front for organised crime or terrorism. For example, legitimate peer-to-peer lending sites will tell you who they (and therefore you) are lending to, how much and what for. If this information is not available, it is not a safe investment.

4. Who pulls the strings?

Every legitimate investment structure must be very clear about who owns, runs and maintains the provider company and the assets that it manages. When making an investment, you should know who is behind the scenes. If you find a tangled web of shell companies, multiple mail-only addresses or VOIP phone lines, puppet directors and unclear or opaque licensing or registration details, don’t risk your money and contact the authorities. Often a scam can look very professional, especially in our modern, online world. A legitimate company will be happy to tell you about its corporate and holding structure, and a legitimate investment should be clear about who owns what and who makes the decisions. Bear in mind also that many bad actors involved in these operations will have done something similar before. If you find a trail of breadcrumbs from a bad investment in the past that leads all the way to a new offer on your doorstep, don’t think it’s a free lunch.

5. Does it pass the smell test?

The last question to ask yourself is quite simple: Is this offer believable? Quite often your gut will tell you if something is too good to be true. Whether you are right or wrong, consider whether you are willing and able to accept the risk. Is the possibility that you have found that rare diamond in the coal worth the financial, emotional and even legal risk you could be running by getting involved in a shady operation? If it stinks to you, give it a wide berth and, as always, don’t hesitate to ask for professional advice. If you are unsure about any financial product, service or offer, speak with your financial advisor or the financial authorities in your country. Every good advisor wants to help get the bad guys and scams out of the market, as they harm our clients, our livelihoods and our industry.

Every investment comes with some element of risk, and generally higher risk can yield higher rewards, but claims of high rewards and low or no risk may mean that at least one of those claims is not true.

If you have been offered an investment that seems too good to be true, feel free to contact us for our impartial professional opinion, free of charge.