Have you ever blindly trusted and implemented a piece of financial advice, and faced a negative outcome? Here are some tips to help you sort out the good from the bad, or at least trigger the proceed-with-caution sirens.
Humans love to give out advice whether sought or unsolicited. But beware, financial advice can be either good or detrimental for your financial health. Some financial advice are truly gems and help set you on the path to financial independence. On the other hand, some money advice can be false, questionable, and downright wrong. If you unwisely follow everything you hear, you bear the risk of losing your hard earned money.
Gaining good sound financial knowledge is vital to grow your personal finance. However, following blindly will only lead you rushing everywhere while bleeding cash. You need to learn to listen, differentiate and weight all money advice you hear or read. Take money advice given with a (large) pinch of salt. Separate the good from the bad.
But, how do you differentiate between good or bad advice?
Below are five common forms of poor financial advice that will likely make you poorer.
1. Speculative Ventures
Just about everyone wants to be wealthy. In our desire to increase wealth, we are susceptible to high-risk investment opportunities in speculative ventures. Committing to investing in speculative ventures which we do not understand will likely drive us to the opposite end — losing money instead of growing your wealth.
Speculative investments can appear at a glance to be very profitable and are often accompanied by very convincing displays of wealth to convince you. In reality, when brought to light, these “gold mines” are often “fools’ gold” leading speculators to lose most or all of their investment.
Below, let’s peek at a few examples of speculative or risky investments:
a) Luxury Collectibles — Luxury collectibles like art, wine, and coins make for excellent hobbies but usually awful investments. Like any other commodity, collectibles go by buying something and hoping there is a willing buyer so its value increases (aka “bigger fool” theory). Two factors determined the price of most assets. One is the investment’s shortage and the other is their practicality. Collectibles that do not fulfil these factors should not be picked up. Another risk tied to luxury collectibles is the care and condition of the collectible.
b) Precious Metals — Investing in precious metals is a speculative investment. The returns are not guaranteed, price volatility is high, and it does not provide any dividends/cash flow. Precious metals are also subject to economic, political and market risks. Furthermore, previous arguments on metals like gold for hedging purposes are increasingly unwieldy in today’s world.
c) Penny Stocks — Penny stocks trade at very low value making it cheap. However, penny stocks face low market capitalization and face liquidity problems. Penny stocks may sound like good value because of their low stock prices. But these stocks generally market at cheap prices for a good reason. They are typically flawed companies with issues such as high levels of debt. Some of these companies may face the risk of being delisted, extended price declines, and insolvency.
d) Small Biotech/Pharmaceutical Companies — Biotech/pharmaceutical companies see a lot of volatility linked to test, patent and regulatory approvals. This is even more so in small biotech/pharmaceutical companies whose fate are solely dependent on a single product successfully being launched.
e) Acquiring Land for Speculative Mining. If you strike precious commodities, you have struck it rich for life. If you strike out, you are stuck with significant debt.
Be cautious of attempts to part your money especially in areas outside your circle of competency. You must know what you’re getting into before you jump in.
2. “Hot” Stock Picks
“Hot” stocks are very volatile movements fueled by speculation, news, and rumors of news. Hot stocks are typically characterized by wide price movements, large spikes in transaction volumes, and focused on a specific company or industry. Hot stocks typically last for a short cycle and are risky, speculative, and short-term in nature.
“Hot” stock tips are unsubstantiated data that conceals fundamental information. Take hot stock tips and buy/sell calls from brokers with a healthy amount of scepticism. Always do your own due diligence before investing. No one knows what will take place next in the financial markets.
Never ever go after a hot stock tip. Regardless of where or who gave the hot tip, take it as an opinion and not a fact. Instead, conduct your own research and make your own decision. You must know why and what you’re investing. Blindly accepting advice is not an investment but gambling. If you are unsure or doubtful, you need to spend more time learning and gaining insights before investing.
3. Investing in Leverage
Debt is sometimes categorized as “good debt” and “bad debt”. Notice that both good and bad debt still contain the word “debt”? A debt is a debt. You have to pay back regardless of the underlying reason for getting into debt. A familiar “good debt” scenario, is getting a loan to buy a house especially among Malaysians who love property. A common investment assumption in Malaysia is that your property will increase in value. (Editor: The actual historical property price increase is closer to official inflation figures).
However, the loan and the property’s assumed promise of success are two separate issues no matter how hard you wish. You should place importance on your ability to service the loan. Know that the dream house being hawked by the property agent may end up being a nightmare if it is not affordable for you. Make well-calculated choices to avoid financial regrets and losing your property and sanity. The inability to service loans can lead to foreclosure and you will endure much stress over this.
Over-leveraging on a property (for example via refinancing) can lead to a catastrophic effect if a severe property correction or glut occurs.
On the other hand, borrowing money or using other people’s money (OPM) can provide excellent leverage. Borrowing can be good advice in the following situations:
- the investment return is higher than the cost of the loan
- your investment is a success,
- you can cash out the investment,
- paid the loan and other costs, and lastly
- pocket the profit.
How nice and convenient! But, in reality, nothing is certain with any investment (even if “guaranteed”). The risks are high and can be compounded many-fold with leverage leading to potentially devastating losses.
There will be risk takers, speculators, high rollers and thrill-seekers. If you are one of these, do be cognizant of the risks involved and have plans to mitigate it:
- Investment Income Risk — The risk of actual return from the investment is lower than expected. Are you able to cover the shortfall
- Interest Rate Risk — If you took a variable rate loan, are you able to meet the obligation if interest rate rise?
- Income Risk — If you were to fall sick or made redundant with no fixed income, do you have a contingency plan?
- Capital Risk — If something forces you to sell your investment, and the value is not enough to cover the loan balance, what are you going to do?
If you are unsure whether to take a loan or be a superman to invest in the stock market, don’t. Wait until you have sufficient cash and/or experience. This way, even if your investment crashes, you don’t have to deal with an even bigger headache — debt.
4. Life/Money Advice from Critics/Quitters/Negative Nancies
We all know of some people who are always quick to give advice. Surround yourself with people better and wiser than you.
“You are the average of the five people you spend the most time with.” ~Jim Rohn
- Mr Critical Carl — Habitually critical people (unless that’s your job) should be avoided. Perpetual critics have nothing good to say about anyone or anything. Critics will cause you to doubt yourself and are experts in pulling you down. Don’t waste your time listening to destructive criticism.
- Mr Quitter Quincy — Quitters are always hyped out for the latest and hottest investment that is going to change their fortunes. But after blowing hot for a few months, they quit when things don’t work out for them in the short term.
- Miss Negative Nancy — This group of individuals are negative about almost anything. They are characterized by being serial complainers, throwing pity parties, and blaming everyone (except themselves) in the world.
Investing is an endurance game grounded in a strong long-term game plan. Learn the rules. Master the game. Forget the naysayers. Break some rules and legs along the way. Enjoy the prize and sweet taste of victory.
5. Biased Money Advice
Scammers prosper in giving this type of advice. Manipulating on one of human most destructive character flaw, greed, is what they do best. It is sadly common how people lose large amount of money and life savings to scammers.
“If it’s too good to be true, it probably is”
Trust your gut feeling and walk away from any such advice. Always check out BNM’s Financial Consumer Alert watchlist.
People are also colored and affected by their own personal experience. As a result, he will be biased for what worked for him and at that point in time.
For example, your friend a few years ago bought and sold a house and earned a nice profit as the property market was booming. He then proceeded to borrow money and flip another five properties allowing him to semi-retire at the age of 40. Do you today listen to his advice on how easy it is to flip property? Do you attempt to flip property like pancakes today? A one-time success of someone else has no bearing on your success if you decide to do the same thing. Furthermore, you may not even know the whole story. Your friend, trumpeting his success, may be biased by telling the success in the most positive way, conveniently leaving out the negative parts and failures.
Growing wealth is like planting a (money) tree. It takes time, care and patience. It can be a slow and boring process. Play it safe by concentrating on your circle of competency and the things you can control. Take a long-term view of your wealth making goals. The bottom line is you need to know where your hard earned money goes and what you are investing in.
Financial pearls of wisdom are rare and few. The dog and rat world we live in has all types of characters including those who would sell their own mother if they could make money. Keep an open mind but do weigh advice whether it’s true and applicable for you. Do your homework. Never accept advice, especially money advice, blindly.
What is the worst money advice you have ever heard? Please share and comment.
Note: This article was originally published at MyPF.my. an established o online education provider.