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Spotting stock market scams isn’t always easy. Sure, there are overt, get-rich-quick promises that read as too good to be true. But these mingle with more subtle frauds, and both new investors and those experienced in the market can fall victim.
For example, this week the Securities and Exchange Commission charged 27 individuals and companies with fraudulently promoting stocks in 250-plus articles published on several investing websites.
These articles “left investors with the impression they were reading independent, unbiased analyses on investing websites while writers were being secretly compensated for touting company stocks,” the SEC said in a statement, concluding the bullish articles were “nothing more than paid advertisements.”
Whether you received your latest stock tip from a cousin, a colleague or a seemingly credible website, be vigilant of potential scams. Here are three ways to avoid getting duped:
1. Be skeptical
When considering a new investment based on a tip, consider the following questions: Is the person offering advice qualified to do so? Does she have something to gain from your following that recommendation? Is the information publicly available?
You might be able to answer these questions when the advice comes from a financial advisor or a friend, but it’s more difficult online. Still, you can look for disclosures that the writer holds the stock in question, read some of his other advice and seek out more information about the stock.
In the wake of its recent charges, the SEC warned investors about following stock recommendations on investment research websites. It also issued an alert about the risks of microcap stocks (or penny stocks), which are more often involved in fraudulent activity.
If you’re unsure about your source’s credibility or motivations, tread carefully — especially if the advice concerns a penny stock. You’ll regret a “hot tip” that goes belly-up more than an apparent missed opportunity.
» MORE: How to buy stocks
2. Do your research
Fraudulent stock tips can carry an air of urgency. And that often tempts investors to make snap decisions that don’t fit with their broader investment thesis.
Before hitting the “buy” button, take time for research. If you’re investing for the long term — say, more than five years — you don’t need to worry about what everyone’s buying right now. The stock will still be there in a week, even if it’s at a slightly higher price.
Where to start? By virtue of being publicly traded, companies must disclose a wealth of information, including regulatory filings, sales and revenue figures and management biographies. You can also find news about and analyst recommendations for many publicly traded companies.
» MORE: How to research stocks
3. Work with a financial advisor
If the thought of researching stocks seems daunting, consider working with a financial advisor. But that won’t get you off the hook for some due diligence.
Look for an advisor that acts as a fiduciary, meaning he or she must act in clients’ best interest. And ask about commissions and fees before settling on a candidate.
The gut check
The stock market can be an exciting place to build wealth, but it’s also burned plenty. And not all stock tips are bad, but a bad one will cost you.
Sometimes the simplest questions provide the best answers: Does it feel too good to be true? If so, don’t think twice about ignoring the advice, even if it’s from friends or family. There’s a reason why so many investors stick with broad index funds. Diversification provides all the benefits of the market’s potential, while reducing some of its risks.