The Puerto Rico Bond Crisis and Its Effect on U.S. Investors

By Thais DelaCuba

The Puerto Rico Bond Crisis has had a large impact on the United States’ almost $4 trillion municipal-debt market, which includes bonds issued by states and other local authorities as well as by cities. As a result of the sinking market, Puerto Rico’s current debt is between $52 billion and $70 billion, which is the third largest in the United States, only behind California and New York.  This amount of debt is alarming because Puerto Rico has a much smaller and poorer population compared to other heavily indebted states. Indeed, according to the Economist, the average state debt to personal income ratio is 3.4% in the United States, whereas Moody’s rating agency puts Puerto Rico’s tax-supported debt at 89%.

The current financial instability of Puerto Rico may have a grave effect on many smalltime investors around the United States. This is because U.S. mutual funds are heavily invested in Puerto Rican bonds due to a special tax exemption, which allows Puerto Rican bonds to be triple tax-exempt. In short, this means that bondholders do not pay federal, state, and local taxes for their coupon interest from the bonds. According to Morningstar, as a result of this exemption, around 70% of U.S. mutual funds own Puerto Rico securities.

The special tax exemption – which was intended to bring investors and business onto the island – has ultimately created the financial crisis occurring in Puerto Rico today. The financial crisis began in 2006 when a federal tax break for corporate income expired, which prompted many businesses to leave. Subsequently, unemployment on the island increased drastically and Puerto Rico began borrow funds to avoid further deficit. Finally, in February 2014, all three major ratings agencies downgraded Puerto Rico’s debt to below investment grade, widely referred to as ”junk” status. This indicates a greater risk of possible default or a debt restructuring. For U.S. investors, this means that the crisis in Puerto Rico will have a severe impact – not only on Wall Street, but also on thousands of everyday investors.

Investors Eager for Puerto Rico’s $70 Billion Debt?

By Fernando Langa

The Puerto Rican economy has significantly suffered because of the territory’s $70 billion debt.  The debt has constrained the island, which has been in recession since 2006, crimping tax revenue and pushing the jobless rate well into double digits.

Rating agencies have reacted to the territory’s economic crisis.  On February 2014, Standard & Poor, Moody’s, and Fitch downgraded Puerto Rico’s debt to junk status.  Standard & Poor believed that liquidity constraints did not warrant an investment grade rating.  Puerto Rican officials and market analysts believed that Puerto Rico would face significant challenges in obtaining any type of investments because of the economy’s inability to portray any type of recovery.

However, on March 11, 2014, Puerto Rico issued $3.5 billion of general-obligation bonds and received more than $16 billion in orders.  Hedge fund managers who received half the amount they requested considered themselves lucky.  Market advisors believe that the fears of widespread default are misplaced.  Moreover, these bonds are tax-exempt and are yielding at 8.73%, which is double the rate of general municipal bonds. Since the last quarter of 2013, Puerto Rico has implemented measures that have already had an impact on the economy: increasing retirement age, raising taxes, and cutting bonuses for public officials.

FINRA is currently examining the trading and demand for these bonds.  The prospectus for the bonds states that the debt would be issued in minimum denominations of $100,000 unless Puerto Rico’s credit rating was upgraded.  However, recent activity shows that the bonds are trading in denominations as low as $5,000.  FINRA fears that these bonds, which are junk-rated, are currently being sold to individual investors as safe, conservative investments (which they are not).

Because Puerto Rico is relying on the credibility and success of these bonds to improve its credit rating and attract investors to its territory, it will be quite unfortunate if FINRA finds some type of violation in the trading of these bonds.

One Size Does Not Fit All: Supervisory Failures Added to Risks Associated with REITs

By Katia Ramundo

On March 24, FINRA announced that it hit LPL Financial with a fine of $950,000 for supervisory deficiencies in the sales of alternative investments. According to FINRA, the deficiencies are related to sales of a broad range of products, including non-traded REITs, oil and gas partnerships, business development companies, hedge funds, managed futures, and other illiquid investments.

FINRA found that between January 1, 2008, and July 1, 2012, LPL Financial violated NASD Rule 3010(a) and 3010(b), NASD Rule 2110 and FINRA Rule 2010 by failing to properly supervise the sale of alternative investments that violated investor concentration limits set forth both at the state level and by LPL itself. LPL created its own automated review system, but the database was not frequently updated to accurately reflect suitability standards. This often meant relying on outdated and inaccurate information. FINRA also stated that LPL failed to adequately train its supervisory staff to properly analyze state standards within their suitability reviews of such products.

REITs, and other alternative investments, may be good for the sales representative, but this does not mean they are suitable for every investor. Various securities regulators have been scrutinizing non-traded REITs sales at LPL for the past year and a half. The firm was one of the six broker-dealers that eventually settled with the Massachusetts Secretary of State and the Massachusetts Securities Division over these sales practices, agreeing to pay $4.8 million in restitution to clients.

REITs are of interest to investors because of their high dividend yield, simple tax treatment, and diversification. However, investors should be cautious of these selling points and balance them against numerous risks and complexities that these investments carry. The values of the REIT shares and dividends depend on the strength of the real estate market. In a bad commercial real estate market, rising vacancy rates would cut into income collected by the REIT, which would reduce the size of dividends offered. FINRA warns that older investors should be particularly cautious about investing large portions of their retirement income in non-traded REITs because the initial investment in a non-traded REIT is not guaranteed and may increase or decrease in value at any time.

Before investing in REITs and various other alternative investments, investors should properly assess their risks. FINRA has started to help underserved investors that have been improperly placed in these highly volatile investments, but investors should also do their part by staying informed. Investors should always inspect a REIT’s website, stay updated on the REIT’s dividend payment history and fees, and should also read the REIT’s prospectus.

A Recent Flood of Cases Has Caused FINRA to Freeze New Arbitrations in Puerto Rico

By Myles Burstein

On March 18, 2014, FINRA announced that due to the recent flood of cases in Puerto Rico, claims would be delayed until FINRA could find additional arbitrators.  In particular, there have been a lot of claims by bondholders who have lost money as a result of misrepresentations as to the risks involved.

Since the city of Detroit filed bankruptcy last summer, Puerto Rico’s municipal bond market has been struggling.  This has provoked investor fears for Puerto Rico’s $70 billion in municipal debt and has set off a wave of claims against the broker-dealers that have sold the bonds.

According to Irvin Jackson, author of the article “Puerto Rico Bond Arbitration Claims Overwhelming FINRA,” “[a]t least 165 Puerto Rico bond fund cases have been filed by investors against UBS and other brokerage firms, claiming that false and misleading information was provided about the safety and security of the investments.  However, some estimates suggest that more than 500 arbitration claims are likely to be filed in the coming months.”  UBS continues to face lawsuits coming from Puerto Rico stemming from the Puerto Rico bond funds.  These types of claims involve the misrepresentation of the risks associated with investing in these bonds.  Generally, these investments were being pitched to elderly investors as safe and secure ways to save for their retirement.

Typically, FINRA arbitration panels have three arbitrators, and a single arbitrator can only hear small claims of $20,000 or less.  According to Linda Feinberg, President of FINRA dispute resolution, FINRA has two ways to handle the shortage of arbitrators in Puerto Rico: it can either recruit locally or send arbitrators to Puerto Rico from nearby locales like Florida.  In the past, this strategy has worked.

FINRA’s BrokerCheck Needs a Gut Check

By Jennifer Allegra

On March 6, 2014, the Public Investors Arbitration Bar Association (PIABA) issued a warning to the investing public regarding FINRA’s failure to disclose “red flag” information in a broker’s background check.  PIABA conducted an analysis and found that FINRA has elected to limit disclosure despite opposition from the SEC.

The FINRA website boasts: “We Believe in Protecting America’s 90 Million Investors, Because That Is Our Job.”  FINRA also encourages investors to protect themselves.  Indeed, the number one tip is for investors to use BrokerCheck to research their brokers’ backgrounds.  In a sense, FINRA is not only inducing the investing public into believing that FINRA is looking out for their best interest, but it is also encouraging investors to rely on BrokerCheck as the holy grail of vetting a broker.  However, an investor would be remiss to rely on BrokerCheck because BrokerCheck fails to include many “red flag” disclosures that could impact an investor’s decision to trust a broker with his life savings.

FINRA is not disclosing all of the information in its possession. Consequently, FINRA is misleading the public to believe that BrokerCheck provides full disclosure.  FINRA maintains a Central Registration Depository (“CRD”), which is a comprehensive national database consisting of information that FINRA gathers as well as the information that each state collects.   However, FINRA has chosen to disclose only a portion of the information it receives from the states.

According to PIABA, FINRA defends the lack of disclosure by protecting the “personal privacy” and “fairness” to its members.  However, it may not be fair to investors who have been induced into relying on BrokerCheck as the number one way to protect their investment. For example BrokerCheck fails to report the reason for which a broker was terminated.  From a logical perspective, FINRA, which has access to this information, should have an obligation to disclose it to the investing public.  FINRA also does not disclose broker bankruptcy and tax liens unless they occurred within the past ten years.  Yet, the investing public should have the opportunity to make a fully informed decision as to whether they want a broker who cannot manage his own finances to be entrusted with the the task of managing theirs.

The problem of inaccurate disclosures are further compounded because often disclosure events slip through the cracks and never make it into CRD’s.  Indeed, the Wall Street Journal recently reported that over 1600 stockbrokers failed to disclose bankruptcy filings, criminal charges, and other red flags.   The report further stated that there was a high correlation between unreported bankruptcies and unfavorable disciplinary records.  Because FINRA relies on self-reporting, brokerage firms have a duty to report this information.  However, much of this important information is falling through the cracks, which makes BrokerCheck disclosures incongruent with FINRA’s purported mission of investor protection.

FINRA Warns Investors That Bitcoins May Be More Than a Bit Risky

By Bradley Zappala

If you’ve been keeping up with the news over the past year or so, chances are you’ve heard of Bitcoin. Yet while most have heard of the virtual currency, many still do not understand exactly what it is, or how it works. Although many investors have viewed Bitcoin as a way to turn a quick profit, recent developments have reminded the public that Bitcoin remains a highly volatile and speculative product, which is inappropriate for investors without an extremely high tolerance for risk.

This notion was reinforced by FINRA in a recent investor alert entitled “Bitcoin: More than a Bit Risky.” Among other things, the alert highlighted recent events that have brought to light some of the very real dangers of investing in Bitcoin. The most prominent of these events was the recent crash of Mt. Gox, once the world’s largest Bitcoin exchange. Though details have been sparse, it is estimated that Mt. Gox lost approximately $460 million worth of its customer’s Bitcoins due to what its CEO described as “weaknesses” in its system.

Although what happened at Mt. Gox has garnered a tremendous amount of attention due to the eye-popping losses, it is hardly the first time something like this has happened in the world of Bitcoin. As FINRA points out, there have been several other instances of hacking and fraudulent manipulations of Bitcoin platforms. Unfortunately for investors affected by the Mt. Gox fiasco, the lack of regulation and oversight of virtual currencies likely means that they will have little recourse in seeking restitution. Worse still, unlike deposits held in a US bank, Bitcoin deposits are not insured.

Outside of the inherent risk of relying on still imperfect software in a fledgling, online industry, FINRA’s Investor Alert also points toward external factors such as deceitful Bitcoin “brokers” and companies with questionable business practices, several of which have rushed onto the virtual currency scene in an attempt to capitalize off of media hysteria and bamboozle unwary investors. One such example FINRA provided was recent SEC charges against a Texas man who allegedly defrauded investors out of $4.5 million in a Ponzi scheme involving Bitcoin. Unfortunately for the duped investors, the man was able to take advantage of the general lack of understanding and knowledge of Bitcoin to perpetuate his fraudulent scheme, using solicitations on Bitcoin-related websites to falsely assure potential investors that investing in Bitcoin carried little to no risk and would return massive gains. As a matter of practice, it is important that anyone thinking about investing in any financial product realize that guarantees of little risk and massive gains are usually indicative of fraud, and certainly do not apply to virtual currency, which in its current state is a highly volatile and speculative investment at best.

Ultimately, potential investors should be extremely cautious of virtual currencies—at least for the foreseeable future. For purposes of illustration, someone who invested in Bitcoin at its peak of almost $1,200 per coin in December 2013 would be looking at a loss of over fifty percent of his investment today, just three months later. This rapid decline in the value of Bitcoin occurred despite several online articles in December that claimed the price of Bitcoin would exceed $10,000—or even $100,000—per coin. As of this writing, however, the price of Bitcoin has steadily declined since its December peak, and many Bitcoin investors who didn’t lose everything on Mt. Gox have nevertheless suffered substantial losses.

Despite the risk posed to investors, it must also be acknowledged that the concept of Bitcoin—and virtual currency as a whole—is spectacularly innovative and could one day develop into a reliable method of payment, allowing for easier and more efficient transactions for both businesses and consumers. One of the chief advantages of Bitcoin is that it is not tied to any specific country, and allows for people without bank accounts or government issued identification—a large portion of the developing world—to transact online or face-to-face with anyone who accepts Bitcoin, simply through the use of smartphones.

At the current time, however, the relatively young technology remains vulnerable to hackers and fraudsters, and we have yet to see whether platforms for buying, selling, and holding Bitcoin can be made secure. Furthermore, without regulations like those that currently apply to the trading of securities, the world of virtual currency will continue to function like the wild west. Fortunately for Bitcoin proponents, it appears that security fixes—some, at least—are in the works, and that some form of governmental regulation and oversight may be on its way in the US. Until then, it is likely that Bitcoin and other virtual currencies will remain highly volatile gambles, which should be considered as investment prospects only by investors who are willing and able to lose.

High Alert: FINRA Warns Investors of Marijuana Stock Scams

by Peter Capacchione

On January 10, 2014, FINRA reissued an Investor Alert titled Marijuana Stock Scams, in response to the rollout of new state laws regarding the legalization of marijuana for both medical and recreational purposes.  With the introduction of such laws, more and more investors have been looking to profit by investing in marijuana-related companies.  While traditionally thinly traded, marijuana-related stocks have become more and more volatile, especially with increased coverage of recent legalization efforts and successes.  Price volatility creates an opportunity for investors to buy low and see huge growth, but with chance also comes risk—here, such volatile stocks carry the risk of burning investors, while also opening the doors to hopeful scammers wishing to defraud eager investors.

FINRA first advises investors on how to weed out potential stock scams.  Oftentimes, investment scammers send out alluring sales pitches through faxes, e-mails, text messages, infomercials, tweets, or even blog posts.  Such correspondence will typically attempt to entice investors with overly optimistic—and sometimes false—market data.  If you have seen Scorcese’s The Wolf of Wall Street, just think of Leo suavely pitching penny stocks from a garage-turned-trading-floor.  FINRA calls such ploys “pump and dump” routines, as the scammers will first pump up unwarranted demand for shares of marijuana-related companies, thanks to the willingness of investors that fall for the sales pitch.  Following the pump, as share prices top off, the fraudsters sell off their shares, profiting while hooked investors are left in the dump.

In the InvestorAlert, FINRA provides a number of tips on how to avoid being duped by dealers of fraudulent stock scams.  First off, investors should always ask why a stranger would be telling them about an incredible investment opportunity.  Investors should also be weary of the source of information that indicates the potential for explosive growth—multiple in-house press releases and promotional information dispersed in a short timeframe should heighten suspicions.  FINRA also warns that research should not simply be limited to the company.  Instead, investors should also conduct research on corporate officers and major shareholders of any marijuana-related company.  A search with the Federal Bureau of Prisons Inmate Locator can help investors learn whether company players or investors have been involved in narcotics crimes or financial fraud.

Furthermore, where a stock trades can indicate the legitimacy of a stock—over-the-counter trading platforms do not typically enforce minimum standards on company shares.    Additionally, who sells a stock can also reveal a scam; a legitimate broker for a stock must be properly licensed, and is usually part of a firm that must be registered with FINRA, the SEC, and state regulators.  Before relying on any sales pitch for a marijuana stock, investors should take advantage of BrokerCheck.  Finally, in addition to reading and verifying the information found in any marijuana-related company’s SEC filings, investors should raise an eyebrow at any company that has changed its name or its business focus.

Possible FINRA Reform On Expungement Records Coming Soon

by Jesse LeVine

Having a reliable and honest broker is crucial for investing. Brokerage firms want brokers who make the firm money without compromising the firm’s reputation and subjecting it to a lawsuit. Investors want honest brokers that make their clients money and look out for their best interest. In an attempt to incentivize investors and ease concerns on the integrity of investing, the Financial Industry Regulatory Authority (“FINRA”) offers a free “Broker Check” service that allows investors to look up any broker who works for a FINRA member firm. FINRA’s Broker Check is available on FINRA’s website and provides a list of broker transgressions and employment history. However, the current regulations on FINRA’s Broker Check have been the subject of much scrutiny in recent months.

Under FINRA’s current rules, settlement disputes between investors and brokers can include provisions that enable brokers to expunge conduct that would otherwise be found in a FINRA Broker Check. This policy has generated so much criticism that FINRA is considering tighter regulations that may take effect as soon as April 2014. FINRA rule changes must be approved the U.S. Securities and Exchange Commission (“SEC”). It is unlikely that the SEC would oppose the rule change; however, brokers will likely challenge the proposed changes to settlement agreements and broker records. According to a study by the Public Investors Arbitration Bar Association, FINRA granted expungement relief in 96.9% of cases from May 2009 through December 2011. This statistic is particularly concerning because investors are not able to see the broker conduct that gave rise to the dispute and expungement.

On January 6, 2014, Senators Jack Reed and Chuck Grassley wrote a letter to FINRA’s Chairman and Chief Executive Richard Ketchum urging reform to FINRA’s current rules on broker records. In part, the Senators stated: “We share FINRA’s view that ‘expungement is an extraordinary remedy that should be granted only under appropriate circumstances,’ and that it should be permitted ‘only when it has no meaningful investor protection or regulatory value.’ However, we believe that meaningful investor protection includes the disclosure of whether a customer dispute was settled. Not just for transparency sake, but also to help prospective investors make informed decisions about which individuals or firms with whom to do business.”

FINRA has yet to make an official decision on the requests made by Senators Reed and Grassley. However, the issue of expungement in broker records has generated enough attention that a resolution is likely to come within the next few months. The letter written by Senators Reed and Grassley can be viewed on Senator Grassley’s website. FINRA Chairman Richard Ketchum wrote a detailed letter in response shortly after receiving the Senators’ letter. Ketchum assured Senators Reed and Grassley that FINRA was reviewing the issues raised in the letter sent by Reed and Grassley. FINRA’s response can be found on Senator Grassley’s website.

What Can You Withstand: Why Risk Tolerance Questionnaires Don’t Always Tell the Full Story

by Maximilian Viski-Hanka

Above-average. Above-average is my “apparent” risk tolerance as determined by an investor risk tolerance quiz developed by Dr. Ruth Lytton at Virginia Tech and Dr. John Grable at the University of Georgia. This quiz is just one of many that any investor could take to have someone, or better yet, an algorithm, determine their risk tolerance. But what really is our own individual risk tolerance? How can something as abstract as a quiz or questionnaire determine what my risk tolerance really is? For example, I was labeled as having an above-average risk tolerance, yet I can’t even bet $5 on a roulette table for fear of losing that meager five dollars. This great fear of losing money, even though I have an above average risk tolerance, is common among investors throughout the world.

When creating an investor’s portfolio, financial advisors are expected to determine their client’s risk tolerance through the use of various assessments and questionnaires. However, when faced with tangible, rather than abstract losses, many investors realize that they habitually over-estimated their own risk tolerance.

These risk assessment questionnaires typically ask questions relating to individual’s behavior in bull or bear markets, years until retirement, age, income, marital status, etc. Unfortunately, these questionnaires don’t cover the full story. As Allan Roth, a Financial Planning Contributing writer and founder of the firm Wealth Logic in Colorado Springs, CO., stated, “the problem is that we are emotional beings rather than logical ones.” As the famous Jim Valvano once said, “If you laugh, you think, and you cry, that’s a full day. That’s a heck of a day.” When investors fill out these questionnaires, their confidence level, mood, atmosphere, and a whole range of other emotions can, and usually do, influence their answers. For example, on a really good day an investor may want to be very aggressive in his investments, whereas on a different day that same investor might feel risk averse due to the emotional turmoil of a death in the family. Emotions and the impact that day-to-day occurrences have on an investor’s investment objectives are highly undervalued when it comes to their risk assessment.

During the credit crises and market drop of 2008 and 2009, many investors discovered that they could not withstand the substantial drop in the market; these events made many investors incredibly risk-averse for fear of losing their livelihood. Mr. Roth, however, feels that such aversion is now a thing of the past because many investors seem to have already forgotten the 2008 crises, and because the high stock prices have instilled renewed confidence in these previously hesitant investors. But what happens if the market experiences a severe pull back? Will people deny the fact that they were risk tolerant? Why can’t questionnaires foresee these fluctuations in risk tolerance?

Several renowned financial analysts believe that questionnaires are unable to accurately determine the “behavioral facets of risk,” As two of these analysts, Brad Klontz, an associate professor in personal financial planning at Kansas State University, and Ron Sages, a wealth management advisor and personal financial planning researcher in Greenwhich, Conn., believe that questionnaires cannot cut to true willingness of a client’s ability to accept loss and risk. To rectify the problem, Mr. Klontz suggests a variety of attributes that should be taken into account when determining a client’s risk tolerance: client gender, planner gender, risk perception, risk composure, anchoring, previous financial loss, etc.

Ultimately, the goal is to figure out what can one do when trying to accurately determine their risk tolerance? In addition to Mr. Klontz’s suggested attributes, investors should thoroughly discuss their risk tolerance with their financial advisors, rather than leaving it up to a questionnaire; investors should only use these questionnaires as general indicators to determine whether any changes need to be made to their perception of risk. Most importantly, instead of determining at the first couple meetings what one’s risk tolerance might be, investors should wait and take some time to contemplate their risk profile. Accordingly, financial advisors should take the necessary steps to ensure that they get the most accurate depiction of their client’s risk tolerance. Finally, advisors should check-in on their clients throughout their time together and make sure that their investment objectives and risk tolerance have not changed. Making sure this information is accurate is crucial and beneficial to all parties involved.

To find out more please visit: Why Risk Tolerance Questionnaires Don’t Work

Five Red Flags That Every Investor Should Know About

by Frank Wehr

When it comes to picking an investment advisor or individual investments in today’s market, it can be very difficult to decide, “What is right for me?”  Many novice investors find themselves in a financial position to make investments, but are simply afraid to take the advice of brokers or take a chance on an investment.  It is easy to see why people are so hesitant when it comes to trusting the advice of a broker.  There is certainly no shortage of stories in the news today about crooked brokers and their brokerage firms and the investors that lost everything on an investment that was supposed to be a “sure thing.”

But it’s not all bad.  Believe it or not, most brokers are smart, professional financial advisors who put investors’ interests first.  Nevertheless, it is important for investors to know what to keep an eye out for when deciding to invest with a particular broker.  The following is a list of 5 red flags that should put every investor on alert.

Note – just because you have experienced one of these red flags does not necessarily mean you have fallen victim to a crooked broker.  However, if you have experienced any of these red flags, it might be time to have a conversation with your broker or perhaps consult another advisor for a second opinion.

1. No Risk Of Principal

Many investors find themselves looking for a way to make higher returns than they would if they left their money in savings accounts, but do not want to risk their principal.  While there are many low-risk options, such as various government bonds and some mutual funds, there is simply no such thing as a totally risk-free return.  Any assurance by a broker that an investment or product offers a totally risk-free return should put the investor on immediate alert.  If your broker tells you a product offers a risk-free return, ask her to guarantee in writing that you will not lose your principal.  That leads me to my next point….

2. Guarantees

FINRA (Financial Industry Regulatory Authority), which oversees all brokers and firms, explicitly prohibits brokers from making guarantees about the performance of an investment.  Every investor wants assurances that they will make money or that they will not lose money.  But, if your broker is making promises against losses, she is also putting her broker license at risk.  Investors should always ask their brokers for explanations of the risks involved in an investment and the reasons why the broker thinks an investment might perform a certain way instead of counting on guarantees.  If the only way a broker can sell you an investment is by making promises about it, you probably do not want anything to do with the product… or the broker.

3. Repayment of Losses

This applies to investors who have already taken some losses and their broker or investment advisor wants to cut them a personal check to repay them for those losses.  Seems like you might have a real stand-up broker who genuinely feels bad about the losses you have taken, right? WRONG! This is highly unethical and would be grounds for termination of any broker caught doing so by their firm.  FINRA rule 2150(c) and every brokerage firm, which is governed by FINRA, prohibit brokers from personally repaying clients for their losses.  If you find yourself holding a check for your losses with “Sorry” in the memo line, it is time to talk to a supervisor.

4. An Investment You Don’t Understand

With the amount of complex investment products and technical jargon that get thrown around by finance professionals, it is easy to see how so many investors can get confused.  For this reason, many investors put their full faith in their broker and purchase recommended products they do not fully understand.  They figure, “I do not really need to understand these products as long as my advisor does.”  Even if your broker is a friend or family member, this is an extremely risky strategy.  If you purchase a product you do not truly understand, chances are you also will not understand your broker’s explanation of why you lost a quarter of your principal investment over a 3-month period either.  When it comes to the more complicated investment products—i.e. UITs, REITs, etc.—the devil is really in the details and often times so is the risk. Furthermore, many of the more complex products, are more expensive to own due to maintenance fees—fees you might not understand without a fulsome understanding of the product itself. But, you do not need to pass the Series 7 to understand what’s in your portfolio.  You should feel comfortable asking your broker to explain how a particular investment functions and why it is appropriate for you.  Put more simply, if you do not understand it, ask your broker to explain it again.  And if you still do not understand it, ask for something else.

5. Penny Stocks

Penny stocks are equities that trade for less than $5 per share.  Penny stocks seem appealing to some investors as they can offer the opportunity to purchase a considerable number of cheap shares early on in a company’s life.  When a penny stock company hits it big—like Monster Energy Drinks, True Religion Jeans and Pier 1 Imports all did—holders of their penny stock stand to make huge returns.  But, most people don’t realize just how speculative penny stocks are and how rarely they make money for their investors.  Most penny stocks are offered by young, small, unproven companies without sufficient capital to run their business. As a result, many penny stock companies go bankrupt and lose all the money invested by their shareholders. Not to mention, penny stocks are a favorite vehicle among financial criminals to defraud and steal from investors.  According to FINRA, penny stock fraud is one of the top 5 most common types of financial scams out there.  The point here is that your broker should NEVER recommend penny stocks unless you specifically ask for something speculative and you are willing to lose all the money you invest in them.  In most cases, you would be better off putting your money on the craps table than in a penny stock.  At least in the casino you get to roll the dice.