Don't get burnt: the investment traps to look out for

Being able to spot a dodgy investment in today's sophisticated market isn't easy, but there are a few tell-tale warning signs to watch out for.

Most styles of investment out there are open to unscrupulous traps and scams, so a good general rule of thumb is to avoid opportunities that look too good to be true, advises ThinkForex senior market analyst at Matt Simpson.

He says that often, poor investments occur because investors buy in after glancing at equity curves with an enticing shape, not realising that these curves are based on closed positions, rather than open positions.

"If you're seeking a fund manager or signal provider to copy trade signals, there's far more to consider than the enticing shape of their equity curve.

"I'm sure you've seen plenty of trading systems with 100% win rates, with screenshots of win after win. Look closer and you'll see it's the 'account history' and not the 'open trade' section, so you're only seeing closed trades. The point is that they could be holding financial losses and providing signals to trades with small accounts."

Check company investor information

It's easy for investors to misinterpret company investor information. In fact, research undertaken by Macquarie University this year to explore the way that companies could present and distort information to influence the judgement of non-professional investors should serve as a warning to all.

Conducted by Dr Andreas Hellmann from the Sydney faculty of business and economics, the research found that the use of management commentary, strategic disclosure and design elements, such as graphs, in company investor presentations could manipulate the facts being presented.

The annual company report is broadly accepted as an accurate document to communicate financial facts between a company and those deemed accountable, such as shareholders.

This fact alone implies a subtle presumption that all information presented in annual reports is objective, neutral and, therefore, useful when making a decision about the company, which isn't always the case.

Dr Hellmann believes that more stringent regulatory parameters are needed to limit the ability of companies to manipulate the decisions of non-professional investors.

And while the federal government introduced the Future of Financial Advice reforms earlier this year to improve the confidence of Australian retail investors in the financial services sector and to reassure people that accessible and affordable financial advice is within reach, the truth is that it's still very easy to fall foul of a poor investment.

Look beyond promised returns

According to Dale Gillham, chief analyst at private investments company Wealth Within, all too often the average punter looks at the promised returns rather than far more important information, such as the reputation of the company, whether they're an international player trying to break into the Australian market, and how they've performed in recent years.

"You need to be backing the best companies, rather than looking solely at their return on offer. So often, people look at the investments offering a good return, but you need to look at how the company is regulated, their compliances with organisations like ASIC, what licenses they have, their track record and, of course, always read the fine print."

Don't invest more than 5-10% of your investment portfolio into smaller funds, leaving the majority with larger and safer options. And before parting with any money, make sure you talk to a financial advisor, Gillham says.

Compound your returns

Even if an investment in a small fund does well, don't be tempted to invest further. Instead, slowly siphon the funds out of that investment and keep compounding your returns and place them into capital safer products, Gillham says.

"Sometimes, some of the smaller funds can be quite nimble and it can work out well quite quickly. However, you can also end up buying shares through these smaller funds that were cheap because someone was trying to dump poor stock quickly. The golden rule is that slow and steady wins the race."

Remember that volatility isn't something you can predict. Just because you've made a good return in a fund over the past 12 months doesn't mean it will do that again for the next 12 months. In fact, statistically speaking, high growth options often drop faster.

Know where your money is

Make sure you know where your money will be physically located and who will be controlling it before parting with a cent. Ensuring it remains in an Australian bank account is always the safest option.

If you're determined to control your own investments, you need to get to a point where you're 100% self-sufficient or know how to use external research as a tool to complement your own trading.

Gillham says the trouble often begins when people sign up to multiple services.

"This leads to analysis paralysis, probable over-trading and generally poor trading decisions. Ironically, it tends to be these same people who don't have time to do it themselves, who find themselves spending all their spare time reading newsletters, trying new services and cherry-picking signals in hope of that big win. No good? Then they move on to the next one, losing even more."

This article looks at the share market in a general way; if you need specific advice regarding your situation, you should consult an appropriately qualified and registered professional.