In the years before the financial crisis, many big-time financial institutions invested heavily in collateralized debt obligations, pools of sliced-up mortgages of varying quality known as CDOs. When the mortgage market tanked, CDO values collapsed, sending Wall Street firms such as Merrill Lynch into a financial tailspin. In retrospect, it's clear the firms didn't fully understand the complex CDOs' inherent risks.
Unfortunately, individual investors who invest in securities they don't understand also can find themselves ambushed by big declines in their investments, says Kent Grealish, a registered investment adviser and co-owner of Quacera Capital Management in San Bruno, Calif.
To prevent your own personal finance meltdown, Herb Montgomery, Certified Financial Planner and president of the Montgomery Financial Group in Orleans, Mass., says investors need to "know where the money is going, what kind of a reasonable return they can get, how much risk they're taking, how much volatility is in the investment and whether it's an investment that's suitable for them." Anything less, and investors can "get into trouble," he says.
If you're working with a good investment adviser, he or she should be able to explain what you're investing in, in terms you can understand, Montgomery says.