You can learn a lot about the credibility of an investment just by looking at the way it’s marketed.
And while most of us are trained to keep an eye out for Ponzi schemes and insider trading, some red flags are harder to spot. So how can you sort out the good from the bad, and make sure you’re investing in legitimate opportunities that will help you reach your investing destination faster?
We’ve talked previously about our top tips for finding a great investment partner, and in this article, we’re going to share four additional red flags to watch out for. If you see someone marketing these types of investments on social media, or hear them use these phrases in a meeting, you should immediately run the other way.
1. Guarantees or “Sure Things”
Most people know this inherently, but it’s still easy to get caught up in the idea of an investment that cannot fail. Just remember: Risk-free investments do not exist.
Even the “safest” and most reliable investments still involve some level of risk. And while it’s true that certain investments may generate more consistent cash flow than others, or have extra layers of protection for investors, you can never eliminate risk completely.
If someone tries to tell you that an investment is risk-free, they are lying to you. On the other hand, if someone doesn’t talk about risk at all, or falters when you ask about their risk mitigation strategies, then they may not have a strong plan in place to help protect your investment.
Look instead for investment opportunities that acknowledge risk but also outline a clear and comprehensive plan for mitigating that risk as much as possible.
2. Real Estate Investments Promising Lowered Income Taxes
This red flag is extremely common, and it’s less obvious than many of the others. You’ve probably seen social media posts or heard podcast interviews where a professional real estate investor talks about how purchasing real estate has allowed them to pay less income tax.
Keep in mind, this claim is entirely different from people who say that real estate investing provides certain tax advantages. This may seem like splitting hairs, but the distinction is important.
For the vast majority of investors, real estate will not lower your income tax. Think of it this way. If you make $500,000 this year, that amount will be taxed at the highest federal rate (around 35% in 2022). Say you then use $100,000 of that income to purchase a rental property. The profits you generate from that rental property will be taxed at a lower rate than the 35%, because of benefits like depreciation. However, the income taxes you owe on the $500,000 you earned at your job will not change.
This is a great example of what we like to call “the two bucket theory.” No matter how well your real estate investments perform, they will not lower the amount of tax you pay on your earned (W-2) income.
The only time that real estate investments will actually lower your earned income tax is if you are classified by the IRS as a real estate professional. But if you’re a busy, high-paid professional, especially one with a dual income, it’s almost impossible to qualify for this status. You would need to spend more than half of your time working in real estate (more than 750 hours a year) and materially participate in each real estate transaction you work on.
So while the person you follow on LinkedIn might be telling the truth when they say that real estate investing has lowered their income tax, they’re misleading you if they try to make you think that those same benefits would apply to your investments.
3. Investments with No Clear Exit Strategy
What is your ideal timeframe for an investment? How long can you commit to having your money locked up? When do you hope to start seeing returns? These are all questions you should answer for yourself before making an investment, but they’re also points you should discuss with any investment partner or advisor before making any commitments.
If that person can not provide a clear answer to your questions about distribution timelines, exit strategies, and liquidity, then you should not invest with them. This indicates that they’re either inexperienced and haven’t thought through all the implications of their investment, or they are trying to hide something from you. Either way, you should not trust them with your money.
4. Poorly Documented Investment Opportunities
Most of us know to watch out for obvious signs of insider trading, such as anyone who markets an investment based on “secret information.” But sometimes the red flags are more subtle. In general, stay away from any investment that doesn’t come with a clearly documented set of terms. And if anything on official paperwork contradicts the information the advisor told you previously, stop and ask more questions before signing anything.
This is important not only for protecting your money, but also for making sure you aren’t unknowingly participating in illegal activities.
Choose a Partner You Can Trust
Investing your wealth is a high-stakes matter, but it doesn’t have to be overwhelming. By doing your work at the beginning to clearly define your goals, vet all potential investments through the lens of those goals, and find partners who back up what they say with clear expertise and documentation, you can invest more confidently and spend less time worrying about your money.
To learn more about the investment opportunities available to you when you partner with First Generation Capital Partners, fill out this form to get in touch.