How to avoid investment scams

How to avoid investment scams

• If an investment seems too good to be true, it probably is.
• Four possible clues to help spot an investment scam include:

1.      Investments offering returns higher than historical averages for comparable investments.

2.      Investments with promised or guaranteed returns.

3.      Investments that go up in a straight line.

4.      Bamboozingly complicated investments.

• Scams Awareness Week is running 21-27 October 2024 (Citizens Advice)

Victoria Hasler, head of fund research, Hargreaves Lansdown:

“Remember how your granny always told you that if something seems too good to be true then it probably is? You’d do well to apply this advice to investments too. Advertisements promising enticingly high returns, or guaranteed returns, or straight-line returns make us very nervous. Why? Because they could be scams. Here’s four big clues to look out for to check if an investment is too good to be true.

1. Investments promising returns that are higher than historical averages.

Investment returns will vary over time, with some years better than others. However, we would recommend caution if anyone is telling you that you can get returns much higher than the historical average over the long. But what is too good to be true? 

We have calculated 20-year annualised returns for a range of assets below. If you are shown an investment and told it can achieve much higher returns than these then you might want to ask yourself why. We’re not saying that it’s impossible to get more than history might suggest, but a higher return is usually compensation for more risk. You should also not panic if your investments return a lot more or less than these returns in any given year. Remember these are averages over 20-year periods and for any one year the returns are likely to be higher or lower than this. (See point 3 below).

Ask exactly where this will be invested, and then have a look at the returns below. For equities you should expect long term returns of around 7-10% per year. Technology returns have been very high in the last few years, skewing the long-term average for the sector, but we wouldn’t necessarily expect that to continue in the coming years. (Note: this has also skewed the US returns a bit as the US market is quite tech heavy).

If your investment is in bonds, then you should probably expect a return somewhere in the region of 3-5% per year. As interest rates fall, we may get a couple of better years for bonds, but again you shouldn’t expect that to last forever.

If you are investing elsewhere, then comparisons get a little trickier. Gold has enjoyed a good run of late, and over the last 20 years has returned 618%. Again, we wouldn’t necessarily expect this to continue, so do be a little cautious here. For investments saying that they will try not to lose you money over the long term then you may want to compare returns to the Investment Association’s Absolute Return sector. Funds in this sector will still go up and down in value, and can lose money over shorter time periods, but are invested in such a way so as to try to hold their value over the longer term. This sector is a bit newer than some of the others, so we have looked at returns over the last 10 years instead.

Source: Lipper IM to 30/09/24

2. Investments with promised or guaranteed returns.

In this world nothing can be said to be certain, except death and taxes. So said Benjamin Franklin. He was referring to the American Constitution, but he could easily have been talking about investments. This one is easy – if anyone is absolutely, iron-clad guaranteeing you a return from anything other than cash, my advice would be to politely decline and run in the opposite direction as quickly as you can. Investments compensate you for taking risk. They are not guaranteed. The closest you’ll get is putting money in the bank (as long as you don’t go over the £85,000 limit that the government ‘guarantees’ as long as it is solvent). Even government bonds have been known to default. Investments are not guaranteed.

3. A journey that is too smooth.

A much-maligned sentence that appears constantly in compliance warnings is: your investments may fall as well as rise in value. I’d almost be tempted to change that line though and say that your investments should fall as well as rise in value. Of course, we all hope that in the longer term our investments will go up, and if you choose your investments wisely, history suggests they will. However, this is never going to be in a straight line. Take a look at the historical return graph for the investment you are considering. Is the line going up in a straight or almost straight trajectory? Markets experience ups and downs, and your investments will too. If the return profile looks too good to be true, then it probably is. In the below illustrative chart, investment A may look attractive, but the path of investment B is a lot more realistic. 

There are some investment schemes which artificially smooth returns to deliberately give investors a better journey (think With Profits funds for example), but these are few and far between. If the line looks smooth then try to understand why, and if you have any doubts then pass and move on to the next investment option.

4. Bamboozingly complicated investments.

One of the rules to follow rigidly in investing is: don’t invest in something horribly complicated when you can get the same outcome from something simple. The problem is that if you don’t understand an investment, then it’s very difficult to tell if it is legitimate or a scam. Does this rule mean that you could occasionally miss out on some good investments? Yes. Does it mean you also miss some horrible blow ups and scams? You bet. Scammers are often keen to present very complicated investment strategies, banking on the fact that you will think them very clever (and probably feel a bit stupid yourself). Ask them to explain it in language you can understand. If they can’t, then walk away.

Scammers are increasingly sophisticated, and it can actually be pretty difficult at times to differentiate a scam from a legitimate investment. Always take your time when looking at investments. Don’t let anyone pressure you into making quick decisions with time-limited deals. And if you’re ever in any doubt that investment returns sound too good to be true then we would strongly recommend seeking advice. It’s better to be safe than sorry.”