How to Smell a Rat summary

You’re on your way to meet your money manager – nervous, because industries you’ve invested in are nosediving. However, at your meeting, your manager tells you that your portfolio is doing great.

Is it time for a sigh of relief? Not necessarily. It could simply be the case that you’re being lied to.

“Try our new, time-tested money making strategy today! We’re arbitraging away proprietary options and employing a split-strike conversion to insure your investment!”

Could you understand any of that? No one can. Yet, this is often what investment jargon sounds like to the inexperienced.

Bernie Madoff advertised his funds as being “exclusive.” To invest with him, you first had to be introduced by a trusted source. Being accepted by Madoff must have felt being granted access to an elite social club – it most certainly didn’t feel like handing over all your money to a fraudster.

Exclusivity itself doesn’t mean much. If an adviser claims to cater to an exclusive, elite group of clients, it could mean a number of things, but it could also just be a trick. Some people find things more desirable if they’re difficult to obtain. For them, having an exclusive adviser feels like a great achievement. But in their eagerness to “join the club,” they become less likely to question their adviser’s investment tactics.

Imagine you’ve met with your financial adviser for the first time, and he offers to manage your money for free. You get all his expertise and he gets nothing. Sounds like a great deal, right? Why should you leave his office only to have to seek out another adviser whom you’ll surely have to pay?

The truth is, financial advisers don’t work for free. No matter what, your adviser is going to get paid. If you don’t pay him, then he’ll make money other ways, e.g., through product recommendations. This can represent a major conflict of interests – between your interest and the interests of those who are paying your adviser.

When you’re searching for a place to get a good haircut, all you have to do is ask your stylish friend for a recommendation. But when it comes to financial advisers, your friends’ recommendations are suspect.

In fact, it’s definitely not in your best interest to choose your financial adviser based solely on your friends’ recommendations.

Part of the U.S. Securities and Exchange Commission’s (SEC) mission is to keep investors safe from fraud. But what exactly do they do? And why are there still so many rats out there?

For one, the SEC ensures high standards of transparency for big-time advisers. All companies and individuals who receive compensation for their investment advice must register with the SEC if they manage at least $110 million worth of assets (unless they only manage hedge funds).