1. Reward is ALWAYS relative to Risk: If any product or investment sounds like it has lots of upside, it also has lots of risk. (If you can disprove this, there is a Nobel waiting for you).
2. Overly Optimistic Assumptions: Imagine the worst case scenario. How bad is it? Now multiply it by 3X, 5X 10X, 100X. Due to your own flawed wetware, cognitive preferences, and inherent biases, you have a strong disinclination – even an inability — to consider the true, Armageddon-like worst case scenario.
3. Legal Docs protect the preparer (and its firm), not you: Ask yourself this question: How often in the history of modern finance has any huge legal document gone against its drafters? PPMs, Sales agreement, arbitration clauses — firms put these in to protect themselves, not your organization. An investment that requires a 50-100 page legal document means that legal rights accrue to the firms that underwrote the offering, and not you, the investor. Hard stop, next subject.
4. Asymmetrical Information: In all negotiated sales, one party has far more information, knowledge and data about the product being bought and sold. One party knows its undisclosed warts and risks better than the other. Which person are you?
5. Motivation: What is the motivation of the person selling you any product? Is it the long term stability and financial health of your organization — or their own fees and commissions?
6. Performance: Speaking of long term health: How significantly do the fees, taxes, commissions, etc., impact the performance of this investment vehicle over time?
7. Shareholder obligation: All publicly traded firms (including iBanks) have a fiduciary obligation to their shareholders to maximize profits. This is far greater than any duty owed to you, the client. Ask yourself: Does this product benefit the S/Hs, or my organization? (This is acutely important for untested products).
8. Other People’s Money (OPM): When handing money over to someone to manage, understand the difference between self-directed management and OPM. What hidden incentives are there to take more risk than would otherwise exist if you were managing your own assets? (more…)