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Resources
A
Guide To Risk Warnings And Disclaimers
by
Brian Bloch
Risk
is fundamental to the investment process, but remains a concept
that is not particularly well understood by most regular investors.
For this reason, risk warnings - those vaguely worded, fine
print disclaimers at the bottom of any investment documents
and websites - are extremely important for both buyers and sellers.
Unfortunately,
although there are many warnings out there, they often remain
unread or are not sufficiently explicit. An investor needs a
fairly substantial level of experience and sophistication to
know what is really meant, or an advisor needs to take the time
to explain it to the investor carefully in person. Yet, all
too often, these conditions do not prevail. Sometimes, sellers
obviously prefer to keep people in the dark in order to make
a sale. In this article, we will take a look at the nature of
risk warnings in order to figure out what gets the message across
properly, and what still leaves investors not truly knowing
what they could be getting into.
Where
Do These Warnings Appear and Why?
Mainly
for legal reasons, firms generally publish some kind of warning
in their brochures and on internet sites. The objective is not
only to explain to the investor the nature of the risks involved
in the particular kind of investment being offered, but also
to ensure that there can be no legal comeback. The warnings
are either in a separate internet link, or in a brochure. In
the latter case, it may vary from a rather small footnote to
a pretty explicit and large-print explanation of what can go
wrong. The length tends to vary from one sentence to a couple
of pages.
Examples
of Written Warnings
Let's
look at some actual written examples of how investors are warned
of what might happen to their money. We will see what the firms
say and just how useful it is.
Example
- Too vague "An investor may get back less than the amount
invested. Information on past performance, where given, is not
necessarily a guide to future performance." Or "The capital
value of units in the fund can fluctuate and the price of units
can go down as well as up and is not guaranteed."
Warnings
like these are very common, regrettably. The problem with these
is that there is no quantification and the warning does not
really hit home. Can you lose 5% or 25%? There is a big difference
between the two. It is unlikely that this warning alone will
ensure that the unwary investor knows what could potentially
happen to his or her money.
Example
- Not easily understood by non-experts "The investments
and services offered by us may not be suitable for all investors.
If you have any doubts as to the merits of an investment, you
should seek advice from an independent financial advisor."
This
certainly warns people to be careful, but how many investors
really understand what is meant by "suitability" or would bother
to double-check? And if the investor trusts the seller, he will
think he is being careful. The odds of an investor actually
going to an advisor are low.
Example
- Relativity and context given "You should be aware that
certain types of funds might carry greater investment risk than
other investment funds. These include our Smaller Companies,
Pacific Growth and Japan funds."
Now
we are moving in the right direction. You can see from this
that the same company has other, safer investments, which you
may prefer. This is no longer a token warning, and points clearly
to lower-risk alternatives.
Example
- The losses can be BIG "Investment in the securities of
smaller companies can involve greater risk than is generally
associated with investment in larger, more established companies
that can result in significant capital losses that may have
a detrimental effect on the value of the fund."
Example
- The losses can be BIG "Investment in the securities of smaller
companies can involve greater risk than is generally associated
with investment in larger, more established companies that can
result in significant capital losses that may have a detrimental
effect on the value of the fund."
Example
- Now that's a warning! "You should not buy a warrant unless
you are prepared to sustain a total loss of the money you have
invested plus any commission or other transaction charges."
No
need for vast experience or a vivid imagination. It is quite
clear that you can lose the lot.
Criteria
for a Good Risk Warning
There
are several criteria that a warning should fulfill if it is
to get the right message across:
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Quantification:
Although this is not always possible, investors should have
some idea as to the proportion of their money that they
could lose. |
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Warnings
should be easy to follow: Any risk warning should be
easy to understand. If you don't understand what the risk
warning is telling you, don't assume that the investment
is right for you just because you trust the seller. An inexperienced
investor could easily be advised to buy anything, ranging
from a basic stock fund to a highly complex packaged product. |
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Signing
is important for both parties: If an investor has to
sign the warning, this demonstrates its importance to him
or her, and provides good protection to the firm. However,
never sign anything your don't understand. |
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Internet
warnings: On the internet, it is all too easy to click
away a warning and carry on with the deal. In a perfect
world, the link and entry would be very clear and the investor
prompted to take the warning seriously. This is not a perfect
world, however, and it's up to investors to make sure they
read the disclaimer before continuing. |
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Personal
explanations: These are the only way many investors
will really understand the risks of a given investment.
If the print warning does not meet your criteria, seek out
personal advice. The explanation should be clear and give
sufficient detail so you know what you could lose, and how,
and what other products might be more or less suitable and
appealing. The seller should also make a note of how the
warning was presented and, if possible, get the investor
to sign this too. |
Ask
Until You Are Sure
As
a private investor, you need to request verbal and/or written
information and explanations until you are sure you understand
the warnings. Don't stop until you are fully aware, in quantitative
terms, of what you stand to gain and lose, and what other potential
investments there are with different risk/reward ratios.
Conclusion
It is essential that investment risk warnings be clear and sufficient
not only to provide legal protection, but also to ensure that
the message truly gets home. Firms and advisors should only
sell products with a warning that conveys the real level of
risk in no uncertain terms; unfortunately, what should be done
and what is common practice are two different things. As an
investor it's crucial to know how much of your money you could
lose and what circumstances could cause this to occur. If you
are uncomfortable with the risks of the investment, remember
there are always lower-risk alternatives.
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