Blogs > Your Money

Dave Patterson and Erin Preston, a father-daughter team of Certified Financial Planner® licensees, provide thoughts and suggestions on a broad collection of personal finance topics.  Information provided in this BLOG is intended to be of a general nature and may not be appropriate for all situations.  Readers should consult with their own financial advisors before relying on any information contained herein.

Friday, August 21, 2009

Avoid Complex Investments

In a recent newsletter to our clients, we included an article titled “Keep It Simple Stupid (KISS)”. We’re sure you’ve all heard of that expression. The gist of that article is that we shouldn’t invest in assets that we do not fully understand. We have found that when investments are more complex, they often contain hidden fees or in some cases, carry higher risk.

In our newsletter article, we noted Warren Buffett’s views on investing in assets you don’t understand. If you haven’t heard of Warren, he’s one of the greatest investors of all time. We said:

“One of the reasons Warren Buffet has been such a successful investor is that he avoids investing in things he doesn’t understand. Back when the tech stock bubble burst in 2000, Warren and his Berkshire Hathaway company were criticized for not including tech stocks in their broadly diversified portfolio. He told everyone that he didn’t invest in tech stocks because he didn’t understand them. We think that’s good advice. As it turned out, Berkshire Hathaway did quite well by avoiding tech stocks.”

Today, we noticed an article in the August 17th edition of Business Week, titled “Old Banks, New Tricks”. The article says that “Lenders haven’t sworn off risky financial products - they’ve just come up with different ones”. The article discusses new products for consumers, companies and small investors.

On the consumer front, “pay-day” loans used to be offered by small lenders. These advances on consumers’ paychecks are now being offered by big banks at rates reportedly as high as 400%! Even though the states have cracked down on these types of loans, the banks are “skirting the state laws” the article said. For example, Ohio recently capped the interest rate for such loans at 28%, yet Fifth Third bank introduced its “Early Access Loan” with an interest rate of 120% after the rate was capped. How they did so was unclear to us.

For small investors, brokerage houses such as Morgan Stanley, Smith Barney and UBS are offering “structured notes”, a type of debt instrument. Over $15 billion were sold in the second quarter. These notes are basically what are known as “derivatives”, where the value of the investment is derived from the value of some other investment. Some of the basic versions are OK for some investors but others are quite complex and include a substantial amount of risk. Many include double-digit teaser rates for the first couple of years. When those rates disappear, investors can realize huge losses.

The bottom line is to take time to understand the financial products that come your way. If they seem too complex or you’re unsure of what the costs really are, pass them by. Keep things simple, and you’ll be making a smart decision.


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