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Family Finances: How to evaluate an investment

- Alan Lavine and Gail Liberman

We often hear hype about the newest and hottest investments.

But once we hear the sales pitches, we're frequently surprised when we conduct our own analyses of what they're truly offering.


  • "Where else can you get a 7 percent-plus safe return these days on an investment?" This pitch was for a private real estate fund. Although real estate was going gangbusters when we first heard it, the particular private fund had at least one major risk: The properties in the fund might never get sold. So you might never get back your money. Although the fund was expecting to go public, it was not yet public. Meanwhile, private funds are subject to less scrutiny and liquidity than a publicly traded security.

  • An exchange traded fund is better than a mutual fund that invests in the same commodity because a mutual fund is limited to stock investments. The exchange traded fund, which generally has lower fees and taxes, invests in the actual commodity, and is not subject to stock market risk. This sounded great--until we learned of a couple added risks for the exchange traded fund: Among those: Theft--in which case, we could kiss our investment goodbye. Almost all parties involved with this fund were based outside the United States. This means if anything happened to our investment, we'd have a pretty tough time suing.

  • Defer capital gains on real estate by participating in a 1031 exchange fund. "Our company does all the work." Omitted information: If you must get out of this investment, it might not be possible. If everything doesn't follow the letter of the law, you not only could lose your investment, but you also could wind up owing the IRS capital gains taxes. Commercial properties in the fund might not be fully rentable. Participating banks could call their loans.

    So how did we nail down these problems? In many cases, we simply read their prospectuses or offering documents. True, this is tough to do. They're often thick and full of legalese. But fortunately, the task is getting easier.

    Information is becoming more clearly labeled, and the Securities and Exchange Commission currently has a proposal to make things simpler for mutual funds via a "summary prospectus."

    When looking at investment documents, here are major factors to examine:

  • Risks. Under what circumstances might you lose money? How likely are these circumstances to happen? Are you able to live with each risk or might such an event put your family out on the street?

  • Fees. Be sure you consider all fees, including brokerage commissions, which may not be in the prospectus. Evaluate "expense ratios," which may prove tough to calculate because they're expressed as a percentage of assets. But these fees, which are charged annually, can take a significant bite out of your investment over the long term--particularly if your investment performs poorly.

  • Conflicts of interest. Are those offering the investment affiliated with any companies hired by it? Are they getting higher fees for their effort than they should?

  • Regulation. What happens if something goes wrong? Is there a regulatory authority that will go to bat for you?

  • Exactly what are you investing in and how is it likely to perform? Is it significantly different from investments you already own? It's important to be diversified.

  • Liquidity. What if you need to cash in your investment? Can you? Are there fees involved? Will you lose principal?

    Unfortunately, many investors in collateralized mortgage obligations and auction-rate notes lately overlooked some of these issues.


    Spouses Gail Liberman and Alan Lavine are syndicated columnists. You can purchase Alan Lavine & Gail Liberman's latest book Quick Steps to Financial Stability (QUE Publishing 2006) online at www.moneycouple.com or at your local bookstore. E-mail them at MWliblav@aol.com.

    To read more columns, please visit the column archive.

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