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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.

Thursday, July 8, 2010

Beware of Advertising Hype

The last couple of years have been hard on everyone. We’ve seen our portfolios decimated by the market crash. In many cases, our homes have dropped in value by 30% or more. Unemployment remains at 9.5%. The prospect is for many new taxes and increases in existing taxes. Few people have received a raise and seniors aren’t getting any inflation adjustments in their social security checks.

Everyone, it seems, is under pressure to increase their income. Unfortunately, that’s tough to do. A few days ago, the stock market retreated back into the 9600 range, with the Dow Jones Industrial Average (DOW) down 7% for the year. Since then it’s jumped back up over 10,000. Does anyone have confidence it will stay above 10,000? It’s frustrating to say the least.

The good news is that inflation is currently low and mortgage interest rates are very low - near 4.6% last week. The bad news is that interest rates are historically low. CD rates, according to bankrate.com, ranged from 1.00% APY to 1.55% APY nationally, last week. Money market rates, according to the same website, averaged just 0.839% nationally, with the highest reported rate at 1.39%.

This bad news, low rate-environment has caused investors to reach for higher yields than they normally might. What you need to remember, however, is that higher returns mean higher risk. We’ve written many times about this issue. Nevertheless, we still hear of individuals touting the high rate of return they were promised on this or that investment.

People are chasing the hottest investments. Of late, that’s been gold. Sure gold may continue its run for a while. But we’d be cautious about buying it now at its lofty price. Many investments offer come-on rates that last for a short-time and are then reduced. Banks often offer higher-rate CDs to attract new customers. Newspapers often have ads offering high-rate CDs, which in some cases have been come-ons by Ponzi schemers.

Ask yourself this question: If an investment is so great, why would the sellers have to spend millions of dollars touting it on TV? Why not put their money in the investment they’re promoting?

What you must remember is that the high rate investment of today, if legitimate, may be at its peak. If you get taken in by the hype about its recent performance, you will likely be buying at precisely the wrong time.

Regardless of what the investment is, if it pays a much higher rate of return than other similar investment vehicles, you must assume that it is inherently more risky and you need to be sure you understand what those risks are. Don’t just ask the seller of the investment. He or she is biased by the prospect of their commission/fee for making the sale. Do your own research or find an independent knowledgeable third party.

1 Comments:

Anonymous Winning Money said...

Greed is always the driving force of the economy. There is always risk in any investment you make, the question is the risk proportional to the reward. Is the risk is high or not is not really the question. The question has always been is the risk worth it?

Risk reward analysis is always the base of any decision any investment bank or hedge fund makes. Gold although may appear at a high price now, consider what will happen when the rest of the world figures our that the debt and the dollar is toast. Everyone will not pile into treasuries, they will buy gold.

July 11, 2010 at 6:46 PM 

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