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Watch Out for These Common Stock Market Scams

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone and is not intended to be a source of investment advice. It may not have not been reviewed, commissioned or otherwise endorsed by any of our network partners or the Investment company.

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Stock scams are a common way to separate stock market investors from their money. They often start simply and many times they include promises of potential profit that are too good to turn down.

But if these scams have anything in common, it’s that they usually end badly: The victim is left owning stock that has little or no value, with the feeling they’ve been cheated. Here are the red flags to look out for so you don’t fall victim yourself — and the steps to take if you suspect you have.

What a stock market scam looks like

How can investors learn to recognize a potential stock scam? Perhaps the best advice is to educate yourself. Understand the different types of scams you might fall victim to and how to steer away from them. And don’t be afraid to ask questions! Asking the right questions and doing your research can help you avoid costly mistakes.

Here are some common types of stock market scams that all investors should be on the lookout for:

Pump and dump

We know how easy it is to spread false information about virtually anything, especially investments. Many fraudsters do that in a scheme known as pump and dump. It starts with promoting a particular stock to potential investors by any means possible — the company’s website, online investment newsletters, chat rooms, email, text messages, phone calls and fax. All methods typically talk about how well the company is doing and may even tie into a real event, such as a new product or higher earnings, but add false information to make the stock sound even better.

This campaign stimulates interest from investors who buy the stock and drive up the price. Then the people who started it all sell their shares and stop promoting the stock, driving the price back down again. If new investors want to sell, they generally have to do so at a much lower price.

Ponzi scheme

These frauds are named after Charles Ponzi, a 1920s con man. In a Ponzi operation, someone at the center of the scheme collects money from new investors. Instead of investing it, they use it to pay inflated returns to earlier investors. The scheme can go on for quite a while, usually until the person at the center is no longer able to attract new investors or too many people want to liquidate their investment.

Despite their nearly 100-year history, Ponzi schemes continue to this day. Back in 2009, Bernie Madoff pleaded guilty to 11 felonies, confirming that he had defrauded his clients of nearly $65 billion over 20 years, making it the largest Ponzi scheme in history.

Pyramid scheme

Pyramid schemes work much like Ponzi schemes, except existing investors recruit new people into the scheme. In many pyramid schemes, “investors” make more from recruiting new members than they do for investing. As with a Ponzi scheme, their investment is used to pay returns to earlier investors until the entire scheme collapses, with most investors losing money.

A well-known pyramid scheme from the 1980s involved United Sciences of America, which sold nutritional supplements through distributors. The scheme preyed on common health fears and promised their products would protect people; it ended in 1987 when three states told the company to change its advertising claims.

Affinity fraud

This type of fraud targets members of a particular immigrant, ethnic or minority group, church or religious organization, the elderly, members of the military or similar groups of people with a common background.

The person offering the deal may claim to be a member of the very same group they’re targeting. Investors often let their guard down when they feel someone with a shared bond is offering them a great deal, and make that deal without ensuring the investment is legitimate or that the return claims are realistic. Affinity fraud can involve virtually any investment, including stock.

Advance fee fraud

This fraud is fairly simple: You own an investment that’s been performing poorly and you want to sell it. Someone contacts you with an offer to buy your investment at an excellent price. All you have to do is send them an advance fee for the privilege of liquidating your investment. You send the money and never hear from them again — and nobody buys your shares.

Internet and social media stock fraud

This type of fraud involves spreading false or misleading “good news” about a particular stock using the tools available online such as websites, social media posts, chat rooms, text messages and emails. The goal is to increase the price of the stock so the originator of the disinformation campaign can sell their shares at a high price. Once that happens and the campaign stops, the stock price is likely to fall (and may fall fast).

Penny stock scams/microcap fraud

Microcap companies are those with few assets and low-priced shares that trade at low volumes, also known as penny stocks. They are frequent targets for fraudsters looking for companies to use for pump and dump and other frauds. In penny stock scams, those perpetrating the fraud buy shares at a low price. They use a wide variety of means (as mentioned above) to raise interest in the stock and increase the price, then they sell. When they stop promoting the stock, the price drops.

The Securities and Exchange Commission (SEC) frequently suspends trading in these stocks before they can become fraud targets.

Pre-IPO investment scam

Many investors want to get in on the ground floor of any potentially lucrative investment opportunity, especially an initial public offering (IPO) of a stock. This type of scam offers the chance to buy so-called hot stocks ahead of the IPO. While there are legitimate offers to buy shares before an IPO, unregistered offerings may violate federal securities laws unless they meet a so-called registration exemption by only being offered to investors who meet income and net worth requirements.

Given the interest in owning IPO shares, this is a good time to ask “why me?” in terms of why they’re offering you this opportunity, as opposed to literally thousands of other investors.

Offshore scam

These scams originate in foreign countries and target U.S. investors. They can involve any of the scams described above. Many fraudsters use Regulation S, which says U.S. companies don’t have to register securities with the SEC if they are sold exclusively outside the country to offshore or foreign investors. Some fraudsters violate this rule by reselling Regulation S stocks to U.S. investors in violation of the law. And since they are outside the country, U.S. authorities have difficulty in prosecuting them.

How to avoid potential stock scams

Although the internet has made it easier than ever to spread stock scams around the world, it’s also made it easier for the average investor to research a potential stock deal to make sure it is legitimate.

Here are some tips investors can follow to keep their money safe.

1. Educate yourself

The more you know about stock scams, the easier it will be to spot one that finds its way to your inbox. Here are some red flags to keep an eye out for — and run far away from:

  • It seems too good to be true. If a deal sounds too good to be true, it probably is. This doesn’t mean that every cheap stock is a bad deal, but it shows why you have to do your research on the stock and the deal you’re about to get into.
  • There’s unverifiable information. If a broker or fellow investor provides you with information regarding a stock trade — the stock price, the company or their own credentials, for example — and you can’t verify those “facts” with another source, there’s a strong likelihood it’s fraudulent. Brokers must be registered with the SEC and the Securities Investor Protection Corporation (SIPC). The SEC and SIPC websites are also great resources for stock and broker information.
  • You’re asked for advance fees. Fraudsters may ask for advance fees for their “services.” Be wary if you didn’t know about the charge beforehand, or if they ask you to pay via unconventional methods (such as cash wire, transfer or Venmo). Only do business on reputable sites and with credentialed individuals and businesses.

It also helps to read articles, conduct stock research online and talk to other investors. The SEC also maintains a page of bulletins and alerts to keep you up to date on the latest scams.

2. Ask yourself, why me?

If someone offers you an investment that sounds too good to be true, ask yourself why, among thousands of investors who might be interested, did someone offer you this chance to invest? Many times, the answer might be that they thought you would be easy to scam.

Go with your gut if something doesn’t feel right — and get out fast.

3. Investigate investments that come through untraditional channels

If a broker from a reputable firm you’ve worked with for many years calls to offer you a great deal, chances are it is legitimate. But if you get a call from someone you’ve never met, do some research before investing.

Google the investment. Ask the caller if you can talk to other investors. Check with organizations like the Financial Industry Regulatory Authority (FINRA) and the SEC to make sure there are no complaints against the people sponsoring the investment. The more questions you ask, the better the chance you’ll find a legitimate investment.

4. Be cautious about offers of high returns with low risk

When it comes to investing, there’s always going to be some risk and typically, high returns come from high risk. While there are still some undiscovered gems out there, it’s unlikely the promise of a novelty stock with high returns but low risk will pan out well. The chances of coming across a gem like this are even lower if someone you don’t know is contacting you with an offer. Check out every investment opportunity carefully.

5. Take your time

Don’t be pressured into investing in anything immediately. Chances are if someone wants you to invest quickly, there are some details they don’t want you to know about. Take as much time as you need to research a potential investment before you decide to invest. Ask questions and get answers.

What to do if you suspect stock fraud

If you suspect a stock scam or have already fallen victim to one, you must act quickly. It isn’t guaranteed that you’ll recover any lost money or the fraudsters will get caught, but your odds are much better the faster you notify the authorities.

Here are the steps you should take:

Contact your bank. If you’ve already made a payment to a bad actor, tell your bank about it as soon as you can. Otherwise, you may miss the short window of time within which you can get your money back. Note this applies to electronic payments; your bank’s unlikely to be able to help you if you handed over cash.

Flag the scam for investment regulators. Not only may this help you, but it may also stop the scammers and prevent others from falling victim. These are the appropriate agencies to contact:

Notify local law enforcement. Bringing law enforcement into the picture may result in catching the scammers. Filing a claim with law enforcement also helps create a paper trail, which is useful in such situations.

Consider enlisting an investment fraud lawyer. An investment fraud lawyer can help advise you on how to best handle the situation — especially if the legal aspect escalates. However, don’t forget that lawyers can cost a pretty penny, and if you’ve already lost sums to the fraudster, hiring an expensive lawyer may not be your best financial course of action.

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Best Funds for Roth IRA: Build Retirement Income

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone and is not intended to be a source of investment advice. It may not have not been reviewed, commissioned or otherwise endorsed by any of our network partners or the Investment company.

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Roth IRAs are retirement savings vehicles that allow participants to make after-tax contributions (as opposed to pretax contributions to traditional IRAs). Account earnings then grow tax-deferred. If the account holder meets certain requirements, withdrawals after age 59 and a half are entirely tax-free, including earnings.

Roth IRAs are a popular choice for retirement savings. According to the Investment Company Institute (ICI), 24.9 million households in the U.S. owned Roth IRAs in 2019. Find out whether you are eligible to join those ranks and whether a Roth IRA is right for you.

Roth IRA: contribution limits

For the 2020 and 2021 tax years, investors can contribute a maximum of $6,000 to a Roth IRA. Taxpayers who are 50 years of age or older can contribute an additional $1,000 in catch-up contributions for 2020 and 2021 for a total limit of $7,000.

Roth IRA contributions phase out between $124,000 and $139,000 in income for single taxpayers (in 2020; amounts are $125,00-$140,000 for 2021) and between $196,000 and $206,000 in combined income for married taxpayers filing jointly ($198,000-$208,000 for 2021.

Roth IRA tax benefits

As a Roth IRA investor, you can invest your account assets in virtually any available investment vehicle. This includes alternatives such as stocks, bonds, put and call options, mutual funds, bank deposits, and exchange traded funds (ETFs). However, because of the unique tax characteristics of Roth IRAs, conventional wisdom argues that some investments may offer more advantages than others.

As noted earlier, Roth IRA investors get no upfront tax break. But when you take distributions, all withdrawals (including earnings) are tax- free as long as you are at least 59 and a half and the account has been in existence for at least five years (as opposed to traditional IRAs, where all distributions are taxable, including earnings).

The unique tax treatment of Roth IRAs, where you pay no tax on distributions, suggests that you consider choosing investments that have the potential to pay high taxable income (and hopefully a higher yield) and concentrate on finding vehicles that offer those characteristics.

Smart investments for a Roth IRA

Here are three investment characteristics that may be well-suited to your Roth IRA:

  • They have high dividends, including real estate investment trusts (REITs), utility stocks and the stocks of companies. Of course, some mutual funds also hold these kinds of investments.
  • They are actively managed or traded, meaning there is high potential for taxable capital gains. This might include an actively managed mutual fund or a portfolio of stocks that you expect to trade regularly.
  • They offer the potential for high growth. Examples might include so-called small-cap stock mutual funds as well as international stock mutual funds that are known to have the potential to grow over the long term. “Small-cap” refers to companies with a small market capitalization. While many consider small-cap companies to have a high potential for growth, they also carry more risk and are more volatile than larger companies.

In contrast, putting investments such as bank deposits, money market funds or low-growth stock mutual funds that pay low dividends into a Roth IRA may not be the best idea because these investments grow slowly and won’t ultimately result in a particularly high tax bill. That means there are few advantages to putting them in a Roth IRA, where all investment income — including dividends and capital gains — ultimately will be tax-free.

Kenneth F. Robinson, a certified financial planner for Practical Financial Planning in Cleveland, takes a narrower view on the best Roth IRA investments. In his mind, a tax-focused approach to investing can make a difference. His first suggestion is that investors put “investments that will grow the most” in Roth IRAs. For Robinson, those include small-cap stock mutual funds as well as international stock mutual funds. Robinson explained how holdings in these two investment categories “have historically earned the most over time.”

Robinson emphasized that if stocks are investments for the long run, “you have to look at them in the long run.” Over a period of, say, 15 years, he said, small-cap and international stocks and mutual funds “typically come out at or near the top” in comparison to their peers in terms of performance. Overall, Robinson thinks investors should look for investments with the potential for the greatest long-term growth.

High-growth investments in a Roth IRA are particularly appropriate for younger investors. Someone who is, say, 35 years old, will have 30 years or more for their Roth IRA to grow. The growth period can be even longer, as Roth IRA owners aren’t required to take minimum distributions based on their life expectancy from their account beginning at age 70 and a half. As a result, the growth period could be 40 years or more, emphasizing the importance of selecting investments that have the greatest potential for long-term growth.

The bottom line

Investing in a Roth IRA can be a great way to accumulate tax-free retirement income. However, the key to that strategy is choosing investments for your Roth IRA that have the potential to grow significantly over time. Doing so will ensure that you take maximum advantage of the tax benefits Roth IRAs offer.

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Your 401(k): Handling Interest Rate Ups and Downs (2021 Update)

Editorial Note: The content of this article is based on the author’s opinions and recommendations alone and is not intended to be a source of investment advice. It may not have not been reviewed, commissioned or otherwise endorsed by any of our network partners or the Investment company.

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With any change in the economy or your life situation, it is a good idea to review your investment portfolio, particularly your 401(k) plan, to make sure your investments are structured to meet your needs at retirement. This is especially true when interest rates are rising so you can take maximum advantage of those high rates. There’s also benefit to checking on your investments when rates are down; certain investments will actually be worth more and you can make a profit by selling or simply enjoy your higher-earning investments.

Interest rates rise and fall based on changes in the economy. The Federal Reserve (the Fed) may lower rates to support the economy when it’s going through a weaker patch and may choose to raise interest rates as the economy begins to gain strength.

Either way, there’s no need to panic. We’ll help you understand what happens to your 401(k) investments in either situation.

What to ask yourself when reviewing your 401(k)

A 401(k) is a savings vehicle that many companies make available to help their employees save for retirement. For tax year 2020, you have until April 15 to contribute up to $19,500 of your earnings into your 401(k) on a pretax basis, meaning anything you contribute is not taxed until you withdraw it, usually at retirement. For 2021 this remains the same, allowing you to contribute up to $19,500.

Some companies match employee contributions up to a certain limit that varies by employer. These contributions are not taxable to you until you withdraw them. Companies offer employees a variety of 401(k) investment options. Some larger companies allow employees to choose from a dozen or more mutual funds, including various stock, bond and real estate funds.

While any time is a good time to review your 401(k) investments, a rise (or fall) in interest rates is a particularly good time to make certain your 401(k) investments meet your needs based on your age, years until retirement and risk tolerance, among other factors.

Virtually all 401(k) plans offer one or more fixed-income investment options. These typically include both government and corporate bonds of varying maturities. For example, a fund might offer a mutual fund that invests in short-term Treasury bills, one that invests in long-term Treasury bonds and one that invests in corporate bonds. Some companies might even offer a fund that invests in so-called junk bonds that pay a higher rate of interest in return for the risk of investing in low-quality bonds.

What to expect when rates rise

An increase in interest rates will eventually have an impact on the types of fixed-income funds in a 401(k). A fund that invests in short-term Treasury bills will react quickest to this change. When the bonds that the funds hold mature over the subsequent year, the fund manager will reinvest the proceeds in bonds that pay a higher rate of interest.

A corporate bond fund, on the other hand, includes bonds with varying maturities. It may take time for the fund to invest its assets in bonds that pay higher interest, as most fund managers spread their investments over maturities between one and 30 years so that at least some bonds are always maturing to potentially be reinvested at a higher rate.

A rise in interest rates also will affect the price of existing bonds in a portfolio. Say the corporate bond fund you own has an XYZ Company corporate bond that pays 4% interest. As market interest rates rise, the value of that bond will decline to a point where the current yield on that bond is closer to the market rate. Since most fund managers anticipate that interest rates will rise, they have structured their portfolios to minimize the impact that an increase will have on the fund’s value.

Let’s return to reviewing your 401(k) investments. When you started your job, you probably picked a mix of investments and haven’t made any changes. That’s fine if you started your job two years ago. But if you have been working for the same company for 10 years, a review is a good idea.

Let’s say that when you started working for the company at age 30, you were single and invested 90% of your 401(k) in stocks and just 10% in bonds. Now, fast-forward 10 years. You got married. And while retirement is still at least 25 years away, it is something you can begin to see on the horizon. It might be a good time to increase your fixed-income allocation to add greater stability to your 401(k) returns — especially if interest rates are rising.

What to expect when rates fall

It’s important to keep in mind that interest rates also can fall. The bad news is this typically happens when the economy isn’t doing so well. The good news is your higher-rate fixed-income investments will be worth more. You can choose to sell them and take the profit or hold them and enjoy earning a rate that’s higher than the one currently available.

Investing when interest rates are falling requires a different strategy. Young investors with many years until retirement who have the bulk of their 401(k) investments in stock should be able to ride out a period of low interest rates without significant impact.

Older investors who see retirement on the horizon or are already retired will find falling interest rates more problematic. Their investments may be concentrated in fixed-income vehicles, or they may be seeking solid long-term fixed-income investments to pay them the retirement income they need. Since nobody can predict how long rates will continue to fall, buying fixed-income investments with staggered maturities, sometimes called a bond ladder, is the best way to make sure you always have money available to take advantage of rising interest rates when they happen.

What’s ahead for 2021

The general expectation for 2021 is that market interest rates will continue to remain at near historically low levels. This is due in large part to the on-going COVID-19 crises as well as observed weakness within the U.S. Economy.

The Federal Reserve has put the federal funds rate on an indefinite pause while simultaneously signaling “easy” monetary policy. In response, banks lowered their own rates and continue to do so overall. This can be observed with the decline in average deposits rates on your savings accounts.

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