Investing Scenarios That Make Me Pause or Run

Avoiding a bad investment deal can be as important as finding the right mix of investments. There are two main types of investing scenarios to avoid: 1) the investment scam, an outright illegal operation and 2) the raw deal, an arrangement that’s legal but clearly not in the best interest of the investor.

The specifics of fraudulent offers and sketchy investments may change as times change. Today’s environment may be ripe for tricks involving green energy or pre-IPOs whereas shady offshore investments may have been more prevalent in the past.

Sales pitches associated with out-and-out scams and lousy deals tend to be consistent. They may promise high returns with no risk or grant access to investments typically reserved for the ultra-wealthy. What’s tricky is that they often contain an element of (half) truth.

Pink Sheets and Penny Stocks: What I Learned

A few years ago, a reputable investment newsletter recommended a pink sheet stock. The writer briefly explained its riskiness for various reasons, including its lack of inclusion in the big leagues of major stock exchanges.

That mention prompted me to learn more about pink sheets, referencing the color of paper the stocks used to be listed on, and penny stocks, referencing a stock price of less than $5.00. I became intrigued with the concept and decided to learn the difference between equities traded on major exchanges and those traded over-the-counter (OTC).

Pink sheets and penny stocks, which are generally traded over the counter, are often touted as nontraditional ways of making lots of money. Just as growth in financial net worth can be a tool for thriving, losing money to worthless and misunderstood investments can thwart the achievement of my goals. So I did some research to determine how to best consider these investments and here’s what I uncovered:

The Intelligent Investor’s Motto: Margin of Safety

In Chapter 20 of The Intelligent Investor, Benjamin Graham covers the ” ‘Margin of Safety’ as the Central Concept of Investment.” This big idea or motto is the “secret of sound investment” distilled to three words.

Graham says “the function of the margin of safety is, in essence, that of rendering unnecessary an accurate estimate of the future.” When considering whether an investment carries a favorable margin of safety, calculations should be based on present circumstances, not overly optimistic or hoped-for future situations.

As I delve into this chapter, I learn that though the margin-of-safety principle is one of the main things, it’s not the only thing relevant to intelligent investing. Its companion is diversification. In addition, I discover that real-life adherence to safety margins isn’t simple or always achievable.

Still, the concept is important and mathematical framework, crucial to the task of selecting securities and building a portfolio.

Convertible Bonds: Understanding How They Work

In Chapter 16 of The Intelligent Investor, Benjamin Graham explores the world of convertible issues, namely convertible bonds and convertible preferred stocks. He also discusses stock-option warrants.

This article is part of a series on Understanding The Intelligent Investor. It continues from the Chapter 15 review on beating the stock market with proven strategies by Joseph Hogue, CFA at My Stock Market Basics.

One of the most important lessons in this chapter is the idea that Wall Street often spins the value of products to favor the commissioned-based seller and issuing company. Instead of relying on advisers or sellers to identify an attractive product, the discerning investor could do well to fully understand both the advantages and disadvantages of investment products.

Let’s delve into convertibles and discover what Graham thinks of them.

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