How to smell a rat
I've recently finish reading a book about financial fraud it is called how to smell a rat and is a very interesting book. It is a relatively small book with about 200 pages and it is all about financial scams. It is written by Kenneth Fisher the CEO of Fisher Investments. The book is all about only five advices that are, also, the chapters of the book
- Good Fences Make Good Neighbors
- Too good to be true, usually is
- Don't be blinded by flashy tactics
- Exclusivity, Marble, and Other Things That Don’t Matter
- Due Diligence Is Your Job, No One Else’s
These are five principles that followed properly are like a shield against most of the scams people can get involved in the financial world. However these are much more general principles we should enforce and let us guide when we face some decision that, in some way, involve risk.
Good Fences Make Good Neighbors is all about avoiding unecessary risks. Many of our day to day way of doing things involve risk however many of the risk we take in our life is perfectly unecessary and, true to speek, should be avoided. For example when you go shopping and buy something for a group of people, being them your friends or family, usually someone from the group take all the risk by paying in advance for the products. With this decision we create the unnecessary risk of someone not being paid by the rest of the people in the group. One way to solve this problem would be to get an specific amount of money from each of element of the group and use this amount to buy things, or split the bill in smaller ones and endorse them to each one of the members. So the first chapter is all about avoiding the risk, if it is not necessary. Notice that this is not a specific principle of finance but one we should use in every decision of our lives.
To good to be true, usually is well this is a pretty self explanatory principle. It points to the mere observation that most decisions we need to take are based in a trade-off principle. For example, if you consider the two variable of (good,value) you notice that when the good of a product rises usually the value also rises. And for most of the cases, if not all, you must find the balance that most suits you. When someone tells you that it is a easy solution for this kind of problems this should not elude you but, instead, raise your concern about the statements because there is a good probability it is a pretty big scam.
Don't be blinded by flashy tactics chapter is all about raising questions and identifying the overall picture of a problem. For example imagine that got a flat tire on the car. Imagine you understand nothing about cars and you ask why should you replace the tire to the mechanic. He could answer you by giving a cinematic explanation full of motion equations and probabilistic theory and show you that in this situation the car could not work properly. Or he/she could tell you that the instability of the car rise and that way is to risky to go with a flat tire with the usual velocity. Many not so well intentioned people use this tactic of raising complexity to avoid to explain clearly some concept with a deceitful purpose.
Exclusivity, Marble, and Other Things That Don’t Matter chapter is all about focus. Focus on things that are related to the problem in question. If you need to repair your car and need to find the best mechanic you should not pay attention to things like the biggest mechanic workshop, nor you should be impressed by the clothes mechanics use or how many advertisements are on the walls of the workshop. You should focus on price of the components and the warranty conditions. When we are trying to solve a problem or trying to find the point in one discussion we should focus in the premises, or arguments, that really matters for the problem we are dealing.
Due Diligence Is Your Job, No One Else’s When trying to ensure something that will hold consequences to you the people who should do the work is you. In other words you can leave the responsibility for others but not the accountability. If you'll delegate some decision to a third party while the consequences remains yours you are putting yourself in a very tricky position. Since a bad decision from the third party will let you with the problems of that decision you should not delegate that work. In other words its your and only your job to do that work. For example I can use my money to buy a bicycle and do myself the study of the market to find the bicycle that fits better my needs. On the other hand I can ask a professional rider to buy a bicycle he thinks is the best solution for me. By letting the rider do the market study for us we are incurring in the non necessary risk of buying a bicycle that is not so good for me after all.
All these principles are very important in the financial world because of the nature of the problem. Basically you can lose everything if you are not cautious, however these are also very useful on our day to day way of decide things.