With Bernie Madoff's Ponzi scheme foremost in many investors' minds, how can you tell whether an investment pitch is a scam? Here are 10 tell-all questions to consider:
1. Does it promise "low risk and high gain?"
Click your heels three times and repeat to yourself, "There is no such thing as a free lunch." It's a fundamental fact of investing that the higher the potential return, the greater the risk that you may never see that return.
2. Will it be "too late" if you don't act now?
Why will it be too late? Any legitimate investment will be there tomorrow, and next week, and next year. Never be pressured into investing in something because tomorrow might be too late. Even if it turns out that the stock doubles tomorrow, you should feel better knowing that you were cautious and responsible with your money. Besides, if someone's giving you a "hot inside tip," you've got a lot more to worry about than whether or not you should act quickly. (See question 10.)
3. Does it claim to predict the future?
"It will double in three months." Oh, yeah? And where did your broker buy his or her crystal ball? Not only is this a ridiculous promise for a broker to make, it's illegal. Report this infraction to his or her sales manager (the next caller might not be as smart as you). And if the matter doesn't get satisfactory attention from a supervisor, contact the Financial Industry Regulatory Agency (FINRA) at www.finra.org.
4. What is the background of the salesperson and his/her employer?
Any individual selling securities to the public must pass a background check, a series of examinations, and be registered with FINRA. Likewise, their employers must also be known to FINRA and the SEC. If you would like to check up on the background of your broker or brokerage firm, use FINRA's BrokerCheck page. But remember, even if they don't have any complaints against them, it doesn't necessarily mean they can be trusted. You could be "Scamee No. 1."
5. Does it "guarantee" anything?
It is not only impossible to guarantee any rate of performance, but doing so will also get your broker tossed out of the industry.
6. Has the salesperson offered to reimburse you for any losses you might incur?
One more no-no that your broker isn't supposed to promise you. This one can get him or her booted, too.
7. Are you one of the "lucky few who have been chosen" to invest in XYZ company?
While this may make you feel special, don't fall for it. You just happen to be one of the lucky few who answered the phone.
8. Does the salesperson claim to have personally invested in the company, too?
What difference does it make whether he or she made a bad investment too? Do you trust the salesperson to call you if and when the investment goes sour? And will he or she get out first?
9. Is the salesperson unwilling to supply a prospectus or financial statements?
If a new company is just going public (an IPO, which stands for initial public offering), you must be given a prospectus. It is long and written in legalese and printed on very thin paper that you can barely read. Read it anyway. Especially the part called "Risks to Investors." If the company in question has been around awhile, ask to see the financial statements for the past two years.
10. Is the salesperson's information "a hot inside tip?"
This is especially important to pay attention to -- not because it could make you rich, but because it could land you in jail. It is illegal to pass on or act on material that is inside information. Anyone telling you otherwise is a liar.
Further trustworthy Foolishness:
This article was originally published June 22, 2006. It has been updated by Dan Caplinger. The Fool's disclosure policy is fond of lunch, free or otherwise.