Principles of investing

THE EASE of access, the unprecedented availability of online investment information and reduced transaction costs have empowered individual investors to enter the financial markets in record numbers.

However, the Internet also poses risks for investors. Research shows that too many investors are not well informed about such investment basics as transaction costs, margin trading, and best execution.

At some point, a customer may want to sacrifice the chance of a better price for speed and vice-versa. But to make an informed choice about that trade-off, a customer needs relevant information about the cost of that choice.

Improved disclosure will allow investors to know the differences between brokers and to make better-informed decisions when choosing a broker. Optimally, increased disclosure could motivate brokers and order execution centres to seek continual improvement in service and better prices for investors -- leading to a market-wide improvement in execution quality.

Challenges for investors: Now let us talk about the challenges that investors face today. Many of you might have been here last year when former SEC Chairman, Mr Arthur Levitt, stood on this stage. With the Nasdaq on the verge of hitting 5,000, Mr Levitt warned that he was concerned that a `Who Wants to be a Millionaire' mentality had overtaken the markets. Too many investors had forgotten about the fundamentals of investing and were investing with their fingers crossed and their eyes closed.

As it turned out, his warnings were right on target. Now, the show Survivor may more aptly describe some investors' feelings about the market.

People may have lost sight of the fundamentals when markets did nothing but go up and up, but in any market investment, you stand a chance of losing your principal. Let me underscore that last point. You might even write it down. Those who meditate may want to make it your investment mantra. Investing is not risk free -- the higher the return, the riskier the investment.

Investing for the long term requires focusing on the fundamentals that make up a solid company. Does the company have a vision, a business model that works, a strong management team, or a quality product? Is it well positioned to embrace new technology or innovation? Does it use its resources to become a better company?

Margin trading risks: A few words about margin. Some investors have been shocked to find out that their brokerage firm has the right to liquidate the investor's account to meet a margin call. This means the firm can sell stocks in its margin customers' accounts -- without any notification and potentially at a substantial loss to the investor. The stock price may rebound, but the investors are stuck paying principal and interest for stock they no longer own.

As investors have increasingly used margin to leverage their buying power in recent years, the number of complaints we have received from investors about `margin sellouts' has increased. It is currently the sixth most common complaint. But many of those complaints -- and more importantly, the financial losses -- could have been avoided had the investor fully appreciated the costs and risks of investing on margin.

Internet cuts both ways: The Internet offers investors access to information that was unthinkable just a few years ago. The Internet also has a downside. There is no button on your computer to separate the good information from the bad.

With its low cost, anonymity, and large number of innocent investors, the Internet is ripe for out-and-out fraud. You need to be wary of illusions of easy money, or fancy Web sites promising you will make a fortune with one quick gamble. Remember the mantra -- the higher the return, the riskier the investment.

Common Internet frauds: The most common types of securities fraud on the Internet are:

*First, market manipulations or so-called `pump and dump' schemes where the fraudsters hype a stock and sell out at the peak leaving ordinary investors holding overpriced stock. Treat predictive information you come across in chat rooms and on bulletin boards as no more trustworthy than a horoscope.

*Second comes Offering frauds, characterised by promises of unrealistic returns with little or no disclosure of risks. In many cases it involves the outright misappropriation of customer funds.

*Finally, newsletters written by fraudsters who recommend or `tout' a company's stock without telling investors that the company paid them to do so.

Be pro-active: You should also be proactive in looking for signs of fraudulent activity. In recent weeks, we have seen a surge of suspicious offerings tied to today's market conditions. The scams are not new. Only the pitches have changed. The scamsters are trying to capitalise on fears of a recession, of an energy crisis, and stock market instability.

The subject lines of spam e-mails now read: ``Beating the market;'' ``Stocks are down: Currencies are on the rise;'' ``Big profits despite market meltdown;'' ``Take a break from the crashing market''. The promises are extraordinary. One states in bold print, ``Currency trading made simple'', and continues, ``200 per cent return in less than 90 days!''

The spams promise that the schemes are ``100 per cent risk-free''. A pitch for investors to buy accounts receivable states: ``Make 48 per cent annually... through guaranteed, fully-secured account receivable acquisitions''.

Remember four things: These scams are real and perpetrators want people to be taken in by them and lose their money. Always remember these four things when making a decision whether to invest:

*If it sounds too good to be true, it is!

*Investigate thoroughly before you invest. Never blindly follow the advice of strangers on the Internet or elsewhere.

*Understand what you are purchasing.

*And most of all, remember that returns are directly related to risks. Remember the mantra. The higher the return, the riskier the investment.

The California gold rush is a thing of the past. In other words, there simply are no quick and easy routes to riches -- successful investing takes time.

(Edited extracts from a speech by Ms Laura S. Unger, Commissioner, US Securities & Exchange Commission)

(Source: www.sec.gov)