This post is part of a series where personal finance expert Dan Solin looks at money secrets that help the rich stay rich. See them all.The headline needs a caveat: some rich people did invest in complex instruments they didn't understand.
They are no longer rich.
Hedge funds are a perfect example.
Few people really understand them. They are not regulated. It is difficult to figure out what they are investing in. It is even more difficult to determine if they have deviated from their original investment strategy.
They promise big returns without additional risk.
Many investors and even pension funds fell for the pitch.
Few took the time to look at the data.
One study of 1,917 funds found that only 17.7% beat their benchmark.
Hedge funds are imploding at an alarming rate. One site that tracks hedge fund failures reports that, since mid-2007, 95 funds managed by 58 firms have blown up.
The dizzying complexities of derivatives, collateralized mortgage obligations and credit swaps are the poster children of the problem. It turns out that no one really understood them. Not the firms that sold them, the hapless investors and funds that bought them, or the credit agencies that rated them so highly.
They also promised high returns with relative safety. You know what happened next.
Einstein is often quoted as saying, "if you can't explain it simply, you don't understand it well enough."
Rich people don't invest in things they don't understand.
Neither should you.
Dan Solin is the author of The Smartest Investment Book You'll Ever Read (Perigee Books, 2006) and The Smartest 401(k) Book You'll Ever Read (Perigee Books, 2008).
Closing Bell: When We All Love the PIIGS (NBG, SQNM, PG, ERTS, KO)
Serious Money: Cheapest Stocks List Shrinks from 26 to 21
Chasing Value: Hasbro Earnings Makes My Point
