How to spot an investment lemon

I have a confession to make. Pop the hood on a 2003 VY Commodore and… I’m lost. I have no idea how to tell if we’re looking at a bargain or a lemon. But if you put a financial lemon under my nose, I’ve learnt a few tricks on how to pick that one out!

Here’s what I know about spotting those financial lemons for yourself:

1. Popping the hood

We all know what popping the hood means with a car. With an investment this means going to a prospectus or company announcements (for shares) or a product disclosure statement (for managed funds).

You can usually get these from a website for the company or investment manager that you are considering investing with. If you can’t find either of these and nobody will provide one, that’s a worry.

2. If it’s too good to be true…

…it probably is. It’s all a matter of relativity. Back in 2008, around the time of the Beijing Olympics, I remember a prominent bank offering a promotional term deposit of 8.88% pa for an 8 month term. It might seem like a lot compared to current rates but that was actually fairly standard at the time. In contrast, today a 4.00% pa return for a 12 month term deposit is closer to normal.

So if a “highly rated fund” is advertising that it earned 10.89% in the last 12 months, there has to be something about it that makes it substantially different from a term deposit. There’s nothing wrong with an investment that is higher risk so long as they’re upfront about it and you know about the difference. It’s the ones that do everything they can to look like cash when they’re not, that you should be watching.

3. Beware the pretty pictures

Not many were taken in by the pretty pictures in the Myer prospectus – they understood that they were considering an investment in a retailer rather than their brand ambassador Jennifer Hawkins! But others are more subtle.

The words will usually tell the story of what you’re actually investing in, even if the pictures don’t. The disclosure docs show a beautiful house or commercial office, but the words reveal that what you’re actually investing in are mortgage backed securities, or an office development with no established tenants.

It’s not that these are necessarily bad investment opportunities, but when the label doesn’t match the contents it should make you wary!

4. Related parties

If an investment manager is raising money, and then mainly giving it to a closely related entity it’s time for a very close and very skeptical look. There’s a pretty clear conflict of interest here where it will be difficult for the investment manager to separate your interests from those of their related business.

This has been commonly seen in the property development business, where the investment manager is merely raising money to fund the developments that are being constructed and sold by a related party. Often the story is about wanting to share a great opportunity with the wider public, but just as often it’s a case of the wider public being taken along for the (extremely wild) ride.

I’m sure there are plenty of other tests that can be applied, but hopefully these four will help you in some way.

Do you have any stories of investments you’re glad you passed on? Something that smelt a little like a lemon?