Paycheck Chronicles

How to Know if a Financial Product Is Too Good to Be True

Using magnifying glass to audit financial records
Using magnifying glass to audit financial records

This article by LT. COL. Shane Ostrom, USAF (Ret), CFP® originally appeared on the Military Officers Association of America website.

If you're pitched a financial product that claims wealth creation with no investment risks, stop and evaluate it, starting with the fundamental laws of money we all must follow to achieve our objectives. Remember, there are no short cuts, good deals, guarantees, or ways around the natural laws of money and wealth building.

It's important to understand “wealth creation” and “savings” are totally different and there are two accepted avenues for managing money: owners and loaners.

Owners (investors) are people who own assets that grow in value over time (or not if you select bad assets or manage them improperly). Owners own stocks, properties, or their own business. 

Only ownership builds wealth. Owners build wealth because ownership involves risk and risk pays. To create wealth, you must have returns large enough to not just offset taxes and inflation but to earn a surplus of returns above taxes and inflation. Only ownership provides this opportunity.

There is no such thing as a “safe” ownership investment. Owners are invested in markets, which naturally go up and down in the short terms. Good investments will increase in value over long terms.

Successful ownership requires knowledge about managing the risks associated with ownership. Manage to risks, and your returns will be the by-product.

Loaners (savers) are paid interest - sometimes called “fixed income.” Loaner accounts are bonds, CDs, savings accounts, money markets, interest-bearing insurance products, etcetera (anything safe or guaranteed is a loaner).

A loaner's objective is wealth preservation not wealth building. Interest-bearing accounts don't pay enough to offset taxes and inflation nor provide surplus returns over time.

Being safe doesn't pay and doesn't create wealth.

If a financial product is not backed by the fundamental laws mentioned above, then it's probably wise to discount it. For example, someone asked me about dividend-paying and fixed-income insurance products. The products didn't involve ownership so they couldn't build the wealth they claimed to build. Plus, the insurance premiums will eat into the minimal dividends and interest payments. Finally, they claimed no investment risks. Remember, no risk, no wealth. And given the fact this was a loaner product and not an owner product, of course there was no investment risk.

Also consider the product's game plan. What can it accomplish, and how credible is the method? For the example above, to me, at best, it could be a wealth-preservation plan. If your objective is wealth preservation, this product might be worthy of close inspection. But ask yourself, discounting the savings aspect, do you need the insurance required by the product? Are there other more effective or cost-efficient methods for achieving the same savings result without the insurance?

Even valid savings or investment vehicles are all a shade of gray to me - neither totally good nor bad. It's about whether the vehicle is best for your objective.

Keep in mind, there are bad products because they simply are not valid. They are never meant to work and only meant to steal your money. These financial schemes make enticing pitches that appeal to your greed or your fear and are about making good money for the salesperson.  

This article How To Know If A Financial Product Is Too Good To Be True originally appeared on the Military Officers Association of America website. MOAA is the nation's largest and most influential association of military officers.

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