If you look at some of the world’s most successful companies it’s pretty clear they typically provide products or services that are straightforward, functional and conceptually easy to grasp. And that’s what you should look for in an investment.
Take Coca-Cola, a simple soft drink found worldwide. Or Apple’s products, very sophisticated bits of gear but fantastically user-friendly. Closer to home we have companies like CSL, Woolworths and BHP that are well-established businesses with products that are easy to understand.
I wonder how many ordinary investors really understood the underlying businesses behind most of the dotcom companies that failed in 2000 or the clear-as-mud operations of money shufflers like Allco Financial Group, which was wiped out in the global financial crisis.
Sure, these events were some time ago. However, I still see very complex “investments” being heavily marketed – Bitcoin, foreign currency trading, contracts for difference and other types of derivative trading to name a few.
Complex doesn’t mean good. If you come across an investment that seems impressive, try this litmus test: Have a go at explaining how it works to someone else. If they don’t know what you’re talking about, then chances are you don’t either and I suggest you pass it up.
If you struggle to understand how an investment works, it’s a fair bet you have almost no chance of knowing what could go wrong and how you could lose money. Keep it simple and it’s harder to go wrong.
Paul Clitheroe is a founding director of financial planning firm ipac, Chairman of the Australian Government Financial Literacy Board and chief commentator for Money Magazine.