Why you should only invest in what you understand

Investor Peter Lynch has been quoted as saying: “Never invest in any idea you can’t illustrate with a crayon.”

Basically, the idea is to be careful putting money into a concept that you don’t understand yourself and that you can’t easily explain to others. A good example of this is a company named “TelexFree” that gained a lot of popularity in Latin American countries during the past year. According to the FBI website about the company (which was revealed to be fraudulent):

According to the complaint affidavit, TelexFree, Inc., and TelexFree LLC (collectively, TelexFree) provided Voice over Internet Protocol (VoIP) telephone services, for which customers can sign up via a website maintained by TelexFree. It is alleged that TelexFree was actually a pyramid scheme, and that between January 2012 and March 2014, TelexFree purported to aggressively market its VoIP service by recruiting thousands of “promoters” to post ads for the product on the Internet. Each promoter was required to “buy in” to TelexFree at a certain price, after which they were compensated by TelexFree, under a complex compensation structure, on a weekly basis so long as they posted ads for TelexFree’s VoIP service on the Internet.

It is alleged that the ad-posting requirements were a meaningless exercise, in which promoters cut and pasted ads into various classified ad sites provided by TelexFree which were already saturated with ads posted by earlier participants. According to the affidavit, TelexFree derived only a fraction of its revenue from sales of VOIP service—less than 1 percent of TelexFree’s hundreds of millions of dollars in revenue over the last two years. The overwhelming majority of its revenue—the other roughly 99 percent—came from new people buying into the scheme. TelexFree was allegedly only able to pay the returns it had promised to its existing promoters by bringing in money from newly recruited promoters.

If you had been approached by a person looking to recruit you to buy into TelexFree and to promote it among your friends and family, what would have been your response? When you saw their “complex compensation structure” would any red flags have been raised in your mind?

I love my land-flipping business because it is something that I can “illustrate with a crayon” and I know that it is a valid business. And I know that there are all sorts of ways to make money out there. But if you can illustrate a business proposal with a crayon, please be careful. VERY careful. There are a lot of sharks out there and I don’t want you to have a setback in your journey towards financial freedom.

Speaking of sharks…it looks like the guy behind TelexFree might not be done

[His new company] appears to be nothing more than a rebranded TelexFree fraud for mobile phones.



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