If an opportunity seems too good to be true - it probably is. This age-old maxim rings especially true when it comes to investment. Unscrupulous individuals operate a variety of scams to con unwitting investors out of their hard-earned money, so it's critical to be wary of any unknown or untrusted source offering an investment opportunity. Here's how to spot some of the most common investment scams:
Be wary of anything suspicious
Investment scams are continually changing, based on what is in the news and as opportunities present themselves for the scam artists, explains Len Hayduchok, president of Dedicated Senior Advisors in Princeton, N.J.
"During tax time, scams regarding returns and refunds were common. During natural disasters, scams directed at people who want to help others are common," he says.
To avoid falling prey to these scams, he suggests following a few basic rules.
"Don't be in a hurry to make a decision," he says, noting that if you feel pressured, that is always a reason to turn away.
In addition, it's always wise to gather as much information as possible on the investment and to do a background check on the salesperson and the sales organization. "If anything is suspicious, walk away," Hayduchok says.
Thanks to criminals like Bernie Madoff, "Ponzi" schemes are among the most infamous of investment scams. These schemes pay "returns" to investors either through their own money (a return of principal) or new investor money, instead of from actual profits.
Bill Hammer, vice president of wealth management at Vanderbilt Partners, gives the following hypothetical example: "If you give me a million dollars to invest, I could pay you 'returns' of 20% ($200,000), through your original capital or through new investors who I have duped into giving me money. The scheme starts to fall apart when investors start redeeming money faster than new money comes in."
To avoid being duped by a Ponzi scheme, Hammer recommends ensuring that the money is kept safe by a reliable third party like Schwab, Fidelity or TD Ameritrade, and that checks are never made out directly to the investment firm.
Other red flags include schemes that promise enormous returns with low risk, firms with limited investment transparency, and those mentioning famous or notable investors to entice you to invest. "True professionals keep their clients' names private," Hammer says.
The "pump and dump"
The pump and dump is a popular investment scam that can be conducted by an outside group of con artists or even individuals within a company.
The scam involves a group of criminals purchasing a large portion of stock in a small, unknown company. These con artists then take to the Internet, spreading rumors about this "up-and-coming" business, advising investors to purchase stock in the company. The increased demand fueled by this false information props up the share price of the company, allowing the criminals to cash out when they feel the stock has reached its peak. This bulk sale causes the share price to fall again, leading the other investors to lose money in the process.
To avoid falling victim to a "pump-and-dump" scam, always be sure that the stock information you receive is accurate and only take advice from trusted sources.
Online investment newsletters
While legitimate online newsletters may contain sound and valuable information, others can be used for fraud. According to the Securities and Exchange Commission, some companies pay crooked online newsletters to recommend their stocks. This isn't illegal as long as the newsletter discloses who paid them, how much they were paid and the form of payment that was accepted. However, if the newsletter is receiving payments while claiming to offer independent, unbiased recommendation, they are committing a crime and may be spreading false information for their own gain.
To avoid these scams, the SEC recommends that investors double check the track record of the newsletter as well as the company or advice that they receive before making any investments, and try to steer clear of small, thinly-traded companies.