5 Most Costly Lies in Finance

Last Updated Jan 5, 2011 9:48 AM EST

Most financial professionals are not trying to confuse you on purpose. They simply spoke so much jargon in business school that they forgot that most people don't know that a "subordinated debenture" is a low-priority debt or that "PEG" is a short-hand way of talking about a company's earnings growth.

Unfortunately this confusing Wall Street-speak could put you in in a fog when approaching financial transactions. And that can make you vulnerable to people who would like to trick you out of your money. When salesmen and con artists see that your normal radar for bad advice, toxic investments and outright scams is getting nothing but fog (the potential result of all the hot air on Wall Street), they ramp up clever lies to separate you from your cash.

You can fight back by knowing Wall Street's 5 most costly lies. When you hear these phrases, run for cover.

Lie #1: This time it's different.
As every market bubble in history approached a spectacularly devastating pop, stupid and scummy "advisors" spit out this ridiculous statement to convince people that gravity no longer applied to this portion of the earth. To be sure, each time that it was(not) different, they were able to articulate a good justification for why it should be.
During the stock market bubble of the late 1990s, for example, it was "different" because "the Internet changes everything!" The Internet would make workers more productive; companies more profitable; communication easier; and foster international business transactions. And, of course, it did.

So did the telephone, the automobile, the typewriter, the printing press, the airplane, the assembly line, the cotton gin, and computers...just to name a few. And yet these market-changing technologies did not change the relationship between stock prices and fundamental indicators of value. Not then. Not now.

When a stock is selling for a price that substantially exceeds it's earnings multiplied by its growth rate, sell it.

Lie #2: It's returns, not fees, that matter
This clever lie is almost always spoken by somebody whose livelihood depends on you overpaying for his or her services, such as planners who sell high-cost "load" funds, annuities, and "wrap" accounts.

The lie is effective because it's based on a partial truth: If you could guarantee higher returns, you wouldn't mind paying higher fees. But in reality, the high fees are a sure thing. The returns are not.

In fact, decades of academic research has come to one inescapable conclusion: The more fees you pay, the worse your average annual returns.

Lie #3: This opportunity won't last!
Again, there's a chance that at least part of this statement is true. Financial regulators could get wind of the "opportunity" you're being sold and shut it down before more people are scammed. For instance, you can't invest with Bernie Madoff anymore. You also missed your chance to invest in hundreds of "initial public offerings" of companies that went belly-up shortly after raising investor capital. Brokers selling these dogs rightly said the "opportunity won't last" because the companies issuing these shares were taking their last rattling breaths, which is why institutional investors refused to buy their shares and why brokers were trying to peddle the stock to you -- or anyone gullible enough to buy it.

In reality good investment opportunities are commonplace and consistent. They don't go away overnight. Take your time evaluating investment options. If you invest in haste, you'll repent in leisure.

Lie #4: Banks don't understand it
When somebody offers you a "guaranteed" 20% profit, the only logical question to ask is: Why are you offering this to me? After all, if the salesman really had a sure-fire route to earning a 20% profit, he/she could go to a bank, borrow the money at 5% or 6% and pocket the remaining double-digit return. They wouldn't need your money. But here the salesman says: "Banks just don't understand this opportunity..."
News flash: Your local bank teller may not be an Ivy League graduate, but someone in that bank building likely is. And they're not at all confused. Neither, by the way, is the promoter who is talking to you. He's functioning on one of Wall Street's favorite truths, best expressed by P.T. Barnum: "There's a sucker born every minute." If you buy an "opportunity" that the banks don't understand, you are that sucker.

Lie #5: You can trust me
If you wanted to peddle some smarmy, rotten investment, would you go find a ugly, rude person to sell it? Of course not. You'd go out and look for a charming, good looking salesman who would smile at prospective marks and say, "You can trust me. I put my Grandmother in this investment."
These guys will pull out your chair, bring you coffee and take your elderly grandmother to the grocery store. Why? The idea is to build trust -- to make you think that a salesman is your friend. If they do this right, you'll be so convinced you can trust them that you'll fail to read the legally required disclosures that spell out all the red flags.

If someone wants you to invest your hard-earned money, make sure you read and understand the fine print. Trust no one with your financial security who doesn't live in your house and share the rewards or penury along with you.

Kathy Kristof is the author of Investing 101, published by Bloomberg Press
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