5 red flags investors should watch out for before choosing a financial product

The investment landscape in the country has seen a remarkable transformation in the last two decades. Investors now have access to a wide range of financial products—from bank fixed deposits (FDs), mutual funds (MFs), stocks, exchange-traded funds (ETFs), and sovereign gold bonds to REITs (Real Estate Investment Trusts), NPS (National Pension Scheme), and other market-linked investment avenues.

Digital platforms have further democratised investing, allowing anyone with a smartphone to start their wealth creation journey in just a few taps. With a plethora of investment options, investors can make decisions based purely on social media trends, recent market performance and word-of-mouth recommendations without aligning investments with their financial goals.

While no financial product can be termed as the best, investors should watch out for clear warning signs before making a decision. Here is a list of red flags that investors should check while making a choice.

Guaranteed high returns with minimal or no risk

If an investment product promises exceptionally high returns and claims little or no risk to the amount invested, you should consider it as a clear red flag. All financial products carry both risks and rewards. If the product offers high returns, the risks will also be high.

Traditional bank FDs offer annual returns of only 6.5%-7.5%. But the risks are also quite low. The odds of your bank not paying the minimum interest, along with the principal on maturity, are extremely low.

But if a product promises doubling of your investments in one year, then you must be extremely sceptical. In fact, you should ignore it as the chances of risks to your principal are high. Ponzi investment schemes often promise such sky-high returns. But in almost all cases, investors have ended up losing money. “Exercise caution with investment opportunities that promise unusually high returns with minimal risk,” experts said.

“Rather than focusing solely on the promised return, investors should understand the underlying asset, the associated risks, and whether the product is regulated by the appropriate financial authority. A healthy level of scepticism can often prevent costly financial mistakes,” said Ramneek Ghotra, Chief Growth Officer, Finvasia Group, a financial technology firm that offers trading and asset management services.

“Be alert to common red flags, such as guaranteed returns, lack of transparency in investment strategies, or refusal to provide detailed information about the investment,” experts said.

Investing without understanding the product

Investors often put their money in a product simply because it is popular or has recently delivered impressive returns. Many investors buy financial products after hearing recommendations from friends, financial influencers or online forums without understanding how those products actually work.

Each financial product is designed for a specific purpose. For instance, a retiree looking for a stable monthly income may find fixed-income instruments more suitable, while a 30-year-old person investing to build a retirement corpus would find market-linked investments that have the potential to generate inflation-beating returns over the long term more attractive.

Ignoring inflation, taxation and liquidity

Many investors typically focus on stability and, as a result, end up getting only nominal returns. In most cases, this would be insufficient to beat inflation and taxes. For instance, a bank FD offering 7% annual interest would look attractive at first glance. But if income tax and inflation are taken into account, real returns would be significantly lower.

Inflation steadily erodes purchasing power, especially over a long-term of say 15-20 years. So, it is essential for investors to assess whether their investments are actually helping them build wealth in real terms. “Many investors focus on nominal returns while overlooking the impact of inflation and taxes on their overall wealth,” Ghotra said.

Liquidity should also be an important factor in investments. Investors should choose products that are highly liquid and can be used in times of emergency. “Investors often commit a significant portion of their savings to products with lock-in periods without maintaining adequate emergency funds. In the event of a medical emergency or unexpected financial need, premature withdrawals may result in penalties or force investors to sell assets during unfavourable market conditions,” Ghotra stated.

Choosing products based on recent performance instead of financial goals

A common behavioural mistake investors make is chasing products that have recently generated high returns. Though past performance can offer good insights, it should never be the sole criterion for making investment decisions.

Investors should follow a goal-based investment approach. Every financial goal has a different investment horizon and risk profile. A home purchase planned within the next three years requires a different investment strategy compared to retirement planning that spans 25-30 years.

If a person is saving for a child's higher education that will require money after 15 years, they should allocate a larger portion to equity-oriented investments during the initial years and gradually shift them towards more stable debt instruments as the goal approaches.

If you need funds within the next two years, it is better to invest in relatively low-risk investment products such as bank FDs and debt-focussed MFs. Matching investments with financial goals, rather than market trends, is a prudent strategy.

Lack of diversification and overdependence on one asset class

Concentrating investments on a single financial product or asset class is another major red flag. If you channel your entire savings into bank FDs for safety or invest entirely in equities during a bull market, then your portfolio is unbalanced, exposing you to unnecessary risks.

Diversification is one of the most effective ways to manage uncertainty. “Different asset classes perform differently across economic cycles. While equities have historically delivered superior long-term growth, fixed-income instruments provide stability during periods of market volatility. Similarly, gold has often served as a hedge during economic uncertainty,” Ghotra said.

Equity mutual funds should form a higher proportion of the portfolio of a young salaried professional with a long investment horizon. The portfolio should also have fixed-income products for stability and gold for diversification. As financial goals evolve, asset allocation should also be reviewed and rebalanced periodically. Ultimately, successful investing is not about finding the highest-return product but about building a portfolio that balances growth, stability, liquidity, and risk.