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Don't Be a Financial Underdog
The world is full of double messages, such as when magazines run stories about weight loss to attract readers and at the same time fill the pages with ads promoting fatty foods. These publications are using double messages to make money from both the readers and advertisers. Double messages seem to be even more fantastic in the financial world.But that doesn't mean the investing underdog has to get eaten alive by the sharks on Wall Street. All investors, no matter how rich or poor, can protect themselves. All they need is a proper education. Unfortunately, that education isn't always easy to come by. "The public is not getting a real education," says Jack Katz, author of Capitalist Dogs: A Financial Fable (Pentland Press). "Instead, the public is getting sales pitches combined with old-hat investment mantras from the professional sales industry like 'buy and hold' and 'you can't time the market'." Here, Katz offers five tricks used by the sharks in the financial world that unleash the truth about Wall Street and provide a real education for the underdog: Be Careful About Assumptions. Assuming is the mother of all financial screw-ups. One of the biggest examples of this was when financiers in Europe and America wrongly assumed Russia wouldn't dare default on its obligations. There was no way for bond holders to get their money back. Anxious investors ran in droves back to that safe haven, U.S. Treasury bonds, driving the price up and the yield down.But bond prices have a seesaw, inverse relationship to the interest paid. The more you want them, the more pricey they become and the less interest they have in paying you any interest. Watch for Fairytale Accounting. Here's an example of unsavory accounting practices: A company decides to add Internet delivery service to their offerings. This company would be a separate entity, but owned entirely by the main company. The new venture helps boost stock value because of all the new publicity. However, about the only real moneymakers on the Internet so far have been pornographic sites. So the main company excludes the losses at the beginning of its financial statement. How can they legally do that? The company does it by mentioning its net profits or profits after expenses as "before other items." You have to search in the financial statement to find out what this means. This way the company hopes to enjoy the exposure provided by the Internet subsidiary while hiding its losses in the paperwork. It's an example of fairytale accounting, but it's officially called pro forma accounting. Companies Try to Sweeten Their Numbers. It's often called creative or aggressive accounting and, in the newspapers, "aggressive earnings management." It's really about fiscal deception: If at first you don't succeed, lie, lie again. Companies are very sensitive to how their earnings look, so they find ways to "paper over" fiscal health problems. With more and more pressure for performance, creative accounting is becoming more and more common. That's why it has been said that cash is a fact, whereas accounting is merely opinion. Financial Literature Protects the Financial Industry, Not the Investor. The financial industry has warning language on its literature that past performance is not a guarantee of future results. Law requires it and studies confirm the irrelevance of past performance with ratings. Companies are protected from lawsuits by this disclaimer, yet the ads suggest that past performance is indeed relevant. This type of advertising also serves the purpose of distracting attention from tax implications and the costs of using financial products. The Master of the Double Message: Government. The government is a master of the double message. Investors are told that the stock market is risky and they should build up firm savings. Yet savings are fully taxed if they are not in a retirement account, which involves penalties for early withdrawals. The government demonstrates its concern that those investing in the stock market might suffer in tough economic times while at the same time they collect more taxes to add to their coffers. Only you can protect your finances. Unless you pay close attention to double messages, you'll end up with your just desserts. And it won't be sweet. Jack Katz, an attorney, died in 2001 just before the first printing of Capitalist Dogs.Visit the book's Web site: www.CapitalistDogs.comThis article is new this week in The Business Journal's small business how-to section. To see what else is new, click here or click on the "how-to" tab at the top of The Daily Business Journal Online home page."