During the past few weeks our readers were educated on the performance of the Colombo stock market by emphasizing on the untapped opportunities it offers to investors. Further on, we have disseminated guidelines on the requirements in entering the market, investing and managing one’s portfolio. Today’s article will discuss practical problems uncounted at the point of making an investment decision.
Misrepresentation of data is an inherent characteristic in developing financial markets. It can occur when a market participant on purpose makes untrue representations of material facts or omits material information required when making an informed investment decision.
A classic example for the above said is giving out false information in relation to the financial performance/future plans of a company. In some instances, certain reports or data in relation to the company will be interpreted omitting key economic and political factors that will impact the performance of the company. Generally, this problem is commonly found with low-priced and speculative securities.
Many investors make incorrect investment decisions based on such information. Investors realize that they have been tricked when they are faced with the following:
They read independent research done about the company.
Price of the stock drops drastically.
The shares turn out to be highly illiquid.
They are exposed to the actual financial reports or the prospectus of the company.
Many learn these lessons at a very high cost. The only way out of such a problem is to learn about the market prior to investing. When you’re advised on an investment, make sure that it meets your objectives. You should understand the risk involved and be comfortable with the risk, costs and liquidity of the investment.
Above all reassure if the information divulged to you was from a reliable source. Bear in mind to request for documents to support their arguments and check the accuracy of such information. It is advised that you read research reports on the company done by independent organisations. We live in a fast-changing world. It is vital that all investors are well informed on the financial, economic and political changes taking place.
Information of this nature is usually coupled with promises of unusual returns for the stock. The equity market is a form of investment. It is by no means a platform where you generate money overnight. Enter the market with the correct mind-set and it would safeguard you from being trapped in such issues.
High-pressure sales calls
Another trump card used by certain individuals is identified as high-pressure sales calls (sometimes referred to as cold-calling). It occurs when an investor receives phone calls using pressure with the view of encouraging the person to purchase certain securities. Once again, these calls target speculative securities and low -cost securities.
The investor is subjected to a process of calls prior to encouraging him to purchase the share. Firstly, the investor receives an introductory call where the repo between the investor and the caller is built up. The caller will showcase his expertise and the confidence will be built up. After a few days, the investor will receive another call where the stock will be introduced. He/she will give out predictions on certain stocks going up in price.
Within the course of the day, the third call will be made to inform the investor on how the prediction was materializing. At this point, the caller would encourage the investor to buy the stock. The repo built up between the two parties along with the prediction that has partly came true, acts as a driving force for the investor to purchase a particular stock.
In many cases, investors are indirectly pressurized to buy the stock. These ‘buy’ signals are identified as once-in-a-lifetime opportunities or as opportunities that should be grabbed without further delay. This prevents the investor from making further inquiries and taking logical and rational decisions.
This is further intensified when the investor is encouraged to sell a stock (a stock he has purchased expecting long-term returns) to invest in the recommended stock. The caller will skilfully manipulate the numbers to deceive the investor. Usually, fundamentally strong stocks will increase in price at a slow rate.
The caller will use this loophole and compare it with the high return that could be expected overnight by investing in the recommended stock. The high risk of losing the investment is not addressed. In the end, the investor is exposed to the risk of losing the capital gain he could have expected through the fundamentally strong stock as well as the capital.
The only way out of such traps would be to be an informed investor. The caller will claim to be a ‘market guru’ and promise to make you a millionaire overnight but the underlying truth is that it is against the workings of the market and such investments entail a very high risk.
Don’t fall prey to the tactics used by the caller asking you to make rash decisions. Always compare the value of the share with its financials and infer if it is worth to be purchased. It may take time and you might not be able to comply with his request but it is worth it as it will save you from financial losses that could have been incurred if the stock was not worth the price.
Do not blindly dole out money to callers. Verify if they represent a licenced stockbroker firm and the caller is a certified investment advisor.
In most cases, these calls are made by individuals who you have based your confidence on and you tend to accept their advice at face value. Remember that the investor is the king and that you should independently analyse the advice given prior to investing, however trustworthy the source may be.
As a responsible investor, you should divulge the details of such callers to the authorities in order to take necessary action against them. Your information will be dealt with utmost integrity.
A problem is seen when the investment made by a stockbroker does not comply with the investment objectives and the risk appetite of the investor. At times, investment advisors fail to recognize the needs of their clients, paving the way to the above stated problem.
He might encourage the client to invest in highly speculative stocks not knowing that he earns a fixed income and can’t afford to invest in high risk stocks. At certain points, clients will be encouraged to trade on credit without a clear picture on his financial credibility.
In some cases, these wrong decisions are manifested when the investor reviews the account and prompts to ask more questions from the broker (inability to liquidate the investment and unexpected interest charged on money invested on credit), when the investor conducts his own research on the stock, etc.
Draw up financial goals before you enter the market. Clearly spell out these goals to the investment advisor. Inform him on your risk appetite, financial credibility, holding power of the investment, etc. Provide the firm with accurate information and don’t inflate your net worth and income.
It is always better to have a discussion with the investment advisor before investing so that both parties will have a clear picture about themselves. It will be easier for them to understand each other.
Moving on, read and understand all the forms and agreements you sign. Two vital agreements that could lead to such a problem are the Discretionary Account and the Credit Agreement. The first gives authority to the broker to trade on your behalf without your approval while the later deals with trading on credit. Think twice before you sign these agreements by weighing the gains and risk involved.
Even if you do agree to sign them, read and understand the documents. You should also keep a tack on all the transactions made. It is recommended to retain your monthly account statements. As stated earlier, do your homework and research on the company.
Build up a good relationship with your investment advisor. Never be afraid to ask questions as it will help him to understand your needs and pick suitable investment opportunities (How is this in line with my investment objectives? What is my risk of losing money on the investment? What has been the past performance of the investment? How liquid is this investment? What is the cost of liquidating the investment? What are the other barriers to sell the stock?).
The above information was divulged in order to inform our readers on the problems faced by global capital markets in general. It does not imply that the Sri Lankan capital market is faced with similar circumstances. However, if an investor is faced with a similar situation (in relation to his investments globally or locally), he will be able to safeguard his investment.