3 Questions To Save Yourself From An Investment Trap!

How to find out if your chosen investment is a real investment or a ‘trap’ in the guise of an investment?

It is not always easy for investors to distinguish between an investment and an investment trap. That’s why we have created three questions to help you easily identify and differentiate between a good investment and an investment trap.

The answers to these three questions will help you understand the true nature of the investment. These three questions will act as a three-tier protection for your portfolio.

Let’s begin!

Table of Contents

1.)First question: Is It well-regulated?
2.)Second Question: Is There A Good Track Record?
3.)Third question: Is there simplicity and transparency?
4.)Conclusion

1. First question: Is It well-regulated?

Is there a formal government regulation for the investment you have chosen?

Is the regulation in its initial stages?

Has the regulation been modified and evolved over time to become somewhat complete?

You should try to find answers to all these questions.

Is government regulation necessary? Isn’t it enough if it is a legal investment?

You buy land in a place. You register it legally. Another person comes and encroaches on that land. Another person claims ownership of the land with forged documents. What can you do to him legally?

You have to seek the help of the court of law. If you file a case in court, it may take even take 10-15 years for the case to be decided. Until then, your investment will be pending. You cannot sell it and convert it into cash when needed. You have to spend on the case. You will also have to suffer mental agony until the case is decided.

Such situations do not generally arise for investments with regulations. In mutual fund and equity-based investments, your investment ownership cannot be snatched away by another person with forged documents.

In regulated investments, if such problems arise, you can approach the customer service center of the company. If you do not get a solution, you can complain to the grievance redressal officers of regulators like RBI and SEBI.

You can send an email and find a solution to all these actions from where you are, without spending a penny. The solution will also be available quickly.

This approach is not available in unregulated investments like real estate and chit funds. For any problem, you have to go to a court of law.

Cryptocurrency, which grew immensely in 2020 & 2021 and caused huge losses, is a good example of this.

Avoiding investments that are not regulated by regulators will be beneficial for investors.

2. Second Question: Is There A Good Track Record?

If you are satisfied with the answer to the first question, the next thing to consider before choosing that investment is ‘What is the past track record of that scheme?’.

There are many and many investment schemes in the market with good performance track records. Only with a track record can you decide what kind of risk and return you will get in that scheme. If there is no track record, we will have to take the risk blindly and invest.

It is better to avoid IPOs and NFOs that do not have a track record.

When researching the past track record of any investment scheme, you need to approach it from three angles.

First, you need to see how much security and stability there is in that scheme.

Second, what you need to look for in the track record is how the past performance of that scheme has been. In particular, you need to see if that return will generate income above the inflation rate.

The third thing to note is whether there is liquidity, which is ‘ease of monetization’. This will be publicly disclosed in FDs and mutual funds. In real estate and chit funds, you can only find out by looking at its track record. Only if the track record is satisfactory in these three aspects should you proceed to the next question.

If you are satisfied with the answer to the first question, the next thing to consider before choosing that investment is ‘What is the past track record of that scheme?’.

There are many and many investment schemes in the market with good performance track records. Only with a track record can you decide what kind of risk and return you will get in that scheme. If there is no track record, we will have to take the risk blindly and invest.

It is better to avoid IPOs and NFOs that do not have a track record. When researching the past track record of any investment scheme, you need to approach it from three angles.

• First, you need to see how much security and stability there is in that scheme.
• Second, what you need to look for in the track record is how the past performance of that scheme has been. In particular, you need to see if that return will generate income above the inflation rate.
• The third thing to note is whether there is liquidity, which is ‘ease of monetization’. This will be publicly disclosed in FDs and mutual funds. In real estate and chit funds, you can only find out by looking at its track record. Only if the track record is satisfactory in these three aspects should you proceed to the next question.

Here are some things to look for when evaluating the track record of an investment:

i)The length of the track record:

The longer the track record, the more reliable it is.

ii) The consistency of the track record:

Has the investment consistently performed well over time, or has it been volatile?

iii) The riskiness of the investment:

How risky is the investment? A higher-risk investment may have a higher potential return, but it also comes with a higher risk of loss.

iv) Your investment goals:

Are you investing for the long term or the short term? The track record of an investment may be more or less important depending on your investment goals.

It is important to remember that past performance is not necessarily indicative of future results.

However, it can be a useful tool for evaluating the potential risks and rewards of an investment.

3. Third question: Is there simplicity and transparency?

Is the investment scheme you have chosen simple to understand and calculate returns, and risk?

At the same time, is it transparent?

Are there hidden fees and hidden risks?

You need to find answers to these questions.

FD, PPF, and mutual fund schemes are simple to understand. At the same time, the risk and return in them can be easily calculated.

In F&O, commodity, and currency trading, the risk we think of may be one thing, and the actual risk may be something else. The return and risk in ULIPs cannot be easily calculated.

In ULIPs, NAV is announced without taking into account the expense ratio. The expense ratio is taken by selling our ULIP units. Because of this, it is not possible to compare and select the return after adjusting for expenses in a ULIP with the return of another ULIP.

At the same time, in mutual funds, NAV is announced only after deducting the expense ratio. This makes it easy to compare and select good investment opportunities from mutual fund schemes.

It is not easy to calculate risk in the fund options available in ULIP schemes. In the large-cap fund option of an insurance company, only 70% will be large-cap. Another company will have a 90% large cap. Because of this, the level of risk will vary. Therefore, it is not practically possible to compare and select ULIP schemes based on risk.

At the same time, there is a standardization in mutual funds. If it is a large mutual fund, at least 80% should be invested in large-cap stocks. Similarly, standardized definitions are given for plans like flexi-cap and multi-cap to facilitate risk calculation. Because of this, it is easy for investors to compare a mutual fund scheme with other similar investment schemes transparently and invest in the best scheme.

Most of the schemes are designed in such a way that the IRR (Internal Rate of Return) in the ULIP scheme cannot be easily calculated.

It is because of this lack of transparency that insurance policies are still being mis-sold.

Low simplicity and transparency make ULIP policies prone to mis-selling. Have you ever wondered? “We get at least two telemarketing calls a week to sell insurance policies. We don’t even get two telemarketing calls a year to sell mutual funds. Why this contradiction?”

Schemes with high simplicity and transparency like mutual funds need not be forced to sell. There is a natural acceptance of such schemes among investors. Investors are willing to buy such investments.

Schemes like ULIPs with low simplicity and transparency are less popular among investors.

Very few people come forward to buy on their own. That’s why we keep getting ‘telecalls’ to sell those plans.

Investment plans with high simplicity and transparency will add strength to your portfolio.

4.Conclusion

To avoid investment traps, ask yourself these three important questions.

1. Is it well-regulated?
2. Is there a good track record?
3. Is there simplicity and transparency?

There is no doubt that these three questions will act as a three-layer protective ring for all your investments.