How Does That Investment Work, Again?
November 8, 2011 - MarcWites
This article is the first in a series of postings that will address issues or “red flags” that may suggest that your broker or investment advisor may be legally responsible for losses in your investment portfolio.
Red Flag: You were pressured into making investments you did not really understand, and those investments have suffered drastic losses.
Here is the scenario: your investment advisor called and told you that she found out about a really great investment opportunity. She confides that she thinks she can get you in on the deal. As she describes the investment she uses unfamiliar terms, but assures you that the investment has “little risk” or is even “a sure thing.”
Sophisticated and Complicated High-Risk Investments
The investment world is chock full of sophisticated and complicated high-risk investment strategies which have leveled the portfolios of finance experts. Unless you truly understand the complexities of these transactions – and fully comprehend the potential risks and the extent of possible losses – you should not be lured into these high-risk transactions. In fact, no trustworthy broker would suggest, let alone encourage, your participation in these speculative investments.
Here are examples of transactions from which you should stay away as they amount to little more than sophisticated gambling:
- “Puts” or “Put Options” give the buyer the right to sell the stock, commodity or other asset to the seller of the “put” at a particular price within a specific period of time. If the price of the asset decreases enough before the time period expires, the owner of the “put” buys the asset at the lower price, resells it to the seller of the “put” and makes a profit based on the “put” price minus the purchase price and minus the cost of the “put.” Unless the asset’s price decreases more than the cost of the put, the put is worthless.
- “Call Options” do the inverse of “Put Options:” they afford the buyer the right to sell the stock, commodity or other asset at a given price within over a specific period of time. In this case, unless the price of the asset increases during the time period more than the cost of the call option, the option is worthless.
- “Margin” purchases may seem like a great way to earn a large sum of money with a modest investment. When you buy “on margin,” you pay only a percentage of the value of the asset you want to buy, but the broker or their company lends you the balance of the purchase price. If the asset’s value increases, even though you only paid for a fraction of the purchase price, you get the entire profit at the time of sale less the interest for the loaned money. However, conversely, if the asset’s price falls, you are responsible for the loss and the interest on the loan. To make matters worse, if you decide to hold on to the asset and “ride out” the downturn, your lender will demand an immediate financial contribution so that their loan stays at a given percentage of the asset’s value.
- “Futures” or “Forward” contracts similarly commit the seller to provide a commodity or other asset at a specified price at a future date. Because the people involved in these transactions do not own the actual asset (most of us do not store pork bellies, maintain granaries or keep a large stash of Yen), but are committed to buying it for resale at the future date, these arrangements can be extremely profitable, or result in drastic losses, depending if the actual market value of the asset at the future date is higher or lower than the contract price.
There are countless versions of similar high-risk ventures involving everything from tangible commodities to foreign exchange funds. If, at your broker’s urging, you put money in an investment containing one of these or one of the following terms, but did not fully understand and agree to the nature of the investment or its risks, you may have a legal claim. Other terms that are red flags: futures, derivatives (including interest, foreign exchange (or “Forex”)), arbitrage, asset-based securitizations (including mortgage based securities), hedges or hedging transactions, and “swap” transactions or contracts.
While there is a place in the market for these types of high-risk, complicated investments, they should never be in the average person’s portfolio, particularly if they do not have a complete understanding about the particular asset’s risks and potential losses.
If you were lured into one of these investment strategies and suffered significant losses you should consider talking with and attorney with expertise related to your broker’s potential liability for your losses.