Top 5 signs of a dud investment product

Everyone loves a good list. There's nothing better than debating the 'Top 5 Australian test batsmen' or the 'Top 5 songs of the 80s' over a cold one—or a red one—with your mates. Whilst I would love to share my thoughts on such critical matters I've promised the II guys I would stick to finance.

My initial thought was the Australian economy; ''The Top 5 contributions by Wayne Swan to Australia's financial strength'. But after several hours failing to get off first base it dawned on me that I needed a topic which gave me some choice.

'Top 5 reasons Joe Hockey would make a good treasurer' wasn't going to cut it - another complete blank. And then I spied a pile of marketing brochures and product disclosure statements; A veritable smorgasbord of problems available for sorting and ranking. And, unlike the bona fides of our alternative treasurers, something that people might laugh along with, not at.

So without further ado, and with an imaginary cold one or red one in hand, let me share with you my 'Top 5 signs of a dud investment product'.

Let's be clear what we're talking about here. This isn't the 'Top 5 things to worry about' or 'Top 5 items to check before signing'. We're talking the Top 5 absolute, sure fire, screaming alarm bell-type indicators that you are about to make an investment on which you are likely to lose a truckload of money.

Let the countdown begin.

5. Commissions

The bigger the upfront fees and commissions the more scared you should be.

Remember how commissions come about. You don't go to an adviser and say 'Listen. I'd really like to buy some XYZ and I'm prepared to pay a commission if you can find it for me'. If that was the way it worked it wouldn't be so scary.

With investment products the process is that a product issuer or promoter goes to the adviser and says 'Listen, I'd really like to sell some BS and I'm prepared to pay a commission if you can sell it for me'. This completely changes the dynamics. The incentive is on selling the product (not sourcing it) and the harder the sales job the larger the commission needs to be.

If it's a tough sale, the product must be a dud. So the bigger the commission, the greater the chance you will lose serious cash.

4. Large upfront tax benefits

Tax incentives aren't introduced to assist investments or industries that are going gangbusters. It doesn't work that way.

They're designed to assist struggling investments or industries that can't stand on their own two feet. And generally, once the promoters get hold of them, they are used to sell investments loosely associated with the struggling industry—or, more bluntly, the cheapest garbage the promoter can find that qualifies for the incentive and can be dressed up into something marketable (with the aid of nice big fat commissions, of course).

So once a large upfront tax benefit forms part of the attraction, there's a fairly good chance the underlying investment is garbage. The other possibility is that the underlying investment is not so bad but the big upfront tax benefit is going to disappear as soon as the ATO finds out about it. This is just as bad,or worse.

If a product relies on large upfront tax benefits, one way or the other you are likely to lose money.

3. High yields

Money may fly off Ben Bernanke's printing press but it doesn't appear out of thin air.

If a product is offering cash yields much higher than bank term deposits then one possibility is that you are taking a lot of additional risk. The other possibility is that the product promoter loves you so much they are donating their own money to the investment so it can be paid to you as additional income.

But if you don't live in the 'land of incredibly generous investment product promoters' then the product has additional risk. It may not be obvious from the PDS—and your financial adviser may be convinced the product is the greatest thing since sliced bread—but the risk is there somewhere. It is a mathematical certainty.

And the harder it is to pinpoint the risk, the more likelihood that it is a scary risk that will end up costing you plenty.

2. Use of the word 'guaranteed'

Rental guaranteed, income guaranteed, capital guaranteed.  Guaranteed guaranshmeed.

If it's guaranteed it's an illusion.

Institutions don't guarantee real risk lightly. If the risk is serious it requires approval from some serious heavy hitters (often the board of directors) to take it. Investment product guarantees are generally covered off on day one so there's no real risk being taken. Rental and income guarantees are covered off by overcharging for the investment. Capital guarantees are covered off by not really investing the money.

It's all smoke and mirrors designed to sell product to punters.

Something that is good shouldn't need to be guaranteed. If it is guaranteed it's probably not good.

1. Products sold by accounting firms

Yes my friends. This is the number one indicator of a dud investment product.

Now, we're not talking about the trusted family accountant calling you up to tell you they think they've spotted an opportunity you might be interested in.

We're talking 'Hi Carol. It's Jack Spiv from Sheistmeister and Co and we have a really exciting opportunity to talk to you about'.

Financial advisors are always selling product. Many of them do it day in, day out. So that's not such a sure fire sign of a dud.

But accountants generally only get involved in selling investments when the commissions are high, the upfront tax benefits are large and often there's high yields and a guarantee as well. Once the accountants get involved in the selling process, you've got several or every single one of the Top 5 'alarm bells' screaming at high volume saying 'don't invest, don't invest!!!'

But you don't need to listen to all of them. Just be comforted in the knowledge that once the accountants are doing the selling, you can run a mile.

So there you have it; The Top 5 signs that you can throw the PDS in the bin and give an investment opportunity a wide berth. I hope this shout out saves you a whole lot of time and, more importantly, a whole lot of money.