Marc Cuniberti: If it seems too good to be true, it probably is
Although new investing fads might sound tempting to many investors, there are pitfalls one has to watch out for.
New investing fads come and go with new products and services that come to market. Some may feature some sort of innovation or technology and some may just be a totally new product that has the wow factor.
Some examples through the years might be the smart phone, crypto-currency, marijuana and solar to name a few. Past newbies have included emu oil, land in various places such as Texas during the oil boom or the Asian interest in Hawaii decades past. Think centuries ago and railroads, the south sea explorations of the new worlds and even tulip bulbs — all fads that came and went.
Investors over the years have seen it all and in the modern world of the stock market, new fads and areas of explosive growth can bring land mines a plenty.
It is said where vast sums of money go, so follows the scam. Although the stock market is highly regulated and scrutinized, we’ve all seen handcuffed executives hauled off to the hoosegow with cameras rolling.
Yes, some crooks are caught but only after money may have disappeared down the crooks’ bank account and been gobbled up by a lavish lifestyle, new Maseratis and million dollar parties, all consumed by the perpetrator before the authorities caught on.
The lesson here is caveat emptor, meaning “buyer beware.” Although public securities are heavily monitored, bad things can still happen as is evident by the fact people still get arrested from time to time for securities fraud, the fraudulent part usually involving an investor’s money.
Although a rare occurrence, with explosive growth can come an increase in corporate malfeasance as well. As fast money pours in, the temptation to bend the rules due to the greed DNA seems to foster more trouble then what might be considered normal. Accounting methods may be skewed or not in compliance, numbers can be fudged and complex financial can fool even the most astute regulators, at least for a while. Although accounting malfeasance can happen in any company, I seem to see more of it in areas where eye-popping gains are made quickly in a new area of interest.
Even if the books aren’t cooked, new areas of interest can lead to manias. A mania is where investors, witnessing incredible gains in short periods of time, eagerly jump onboard to catch the quick riches train, and a boom-bust cycle may be triggered. Media coverage of the impressive gains by some only fuels the madness. Think dot-com stocks in the late ‘90s, real estate in the mid 2000’s and more recently, crypto-currency.
Even if you avoid the pitfalls mentioned, you can still get snagged in totally legal maneuvers in a fast moving and new area of interest. Small startups pop up like weeds in fast moving markets and you only need to look at the amount of IPO’s (initial public offerings) of the new companies hoping to catch some of the fast flying money.
Some have great business models and some have terrible ones. Think Pets.com among the many now defunct companies that came to market with little more than a name or catch phrase. The lesson here being not all companies in the new investment arena will survive. A carte blanche shopping list can be a dangerous practice. In other words, don’t just buy a name or company because they’re in the current spotlighted area.
Finally with all the money being thrown at the new companies, previously struggling owners see their bank accounts quadrupling in stunningly short amounts of times. Seeing a rising stock price, and often an incredibly fast moving one, the company can look to cash in by offering more shares of stock. They might open their “stock safe” where unissued shares reside and sell millions more on the public market.
Although this move will likely bring even more copious amounts of money into company coffers, the price of the existing stock may plummet as the new shares dilute existing shareholder value. Couple this with the fact that usually employees may have received shares long ago when the company first went public, those shares are usually restricted, meaning eventually the employees will be allowed to sell those shares on the public markets, further diluting your shares. In both cases more shares for sale means each existing share already in the market will be worth less due to the sheer number of shares being offered.
Although new ideas and technologies can be alluring to investors, the pitfalls are real and can be numerous. It might be prudent to wait until the smoke clears and a more rational market begins to materialize.
This article expresses the opinions of Marc Cuniberti and are opinions only and should not be construed or acted upon as individual investment advice. Mr. Cuniberti is an Investment Advisor Representative through Cambridge Investment Research Advisors, Inc., a Registered Investment Advisor. Marc can be contacted at SMC Wealth Management, 164 Maple St #1, Auburn, CA 95603 (530) 559-1214. SMC and Cambridge are not affiliated. His website is http://www.moneymanagementradio.com. California Insurance License # OL34249.
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