The Investment Scientist

Posts Tagged ‘asymmetric information

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Oil and Gas Investment Scam

In the last month alone, I’ve gotten calls from two clients asking me if they should invest in tax advantaged oil and gas investments being pitched to them?  Both of these clients are physicians.

The pitch is that oil and gas investments are like IRA accounts, but without the contribution limit. Whatever amount you invest can be written off right away.

The pitch is quite alluring to high-income professionals like physicians who are facing higher taxation. But it sounds too good to be true, so I did a study.

It turns out what is being pitched as “tax advantaged” is in fact the riskiest part of an oil and gas investment.

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When talking to a prospect about my advisor services, I would ask him his philosophy about risk. The conversation would usually go like this:

Prospect: “I don’t like losing money.”
Me: “What do you mean? Can you be more specific?”
Prospect: “I don’t mind giving up a little upside; I just don’t want to lose too much on the downside.”
Me: “So you are concerned about volatility risk?”
Prospect: “That’s it.”
Me: “Other than that, are there risks you are concerned about?”
.. (long pause)
Prospect: “Not that I can think of.”

It is not surprising that most investors equate investment risk to volatility; they see assets prices (and their portfolio values) fluctuate every day. But there is much more to investment risk than what meets the eye. And what investors don’t see usually is far more insidious. For example:

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Michael Zhuang is principal of MZ Capital, a fee-only independent advisory firm based in Washington, DC.

Twitter: @mzhuang

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