How to spot the danger signs of fraud

December 10, 2012: 5:00 AM ET

When it comes to investments, remember the old saw: If it sounds too good to be true, it probably is.

By James Sterngold, contributor

FORTUNE -- When it comes to fraud, most people assume that financial neophytes are the most frequent victims. But recent research by AARP contradicts that notion. The dupes, it turns out, are more likely to be male, well-educated, older, and more financially literate than the average person, says Doug Shadel, AARP's director for Washington State. He wrote a book this year titled Outsmarting the Scam Artists, based on interviewing people who'd been fleeced and listening to con artists spin their magic on calls recorded by law enforcement.

In short, overconfidence causes more problems than ignorance; believing you are impervious to tricks is precisely what reduces you to financial prey. (The resulting embarrassment is one reason, says Shadel, that as many as 60% of victims never report frauds.)

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You'd think that the financial crisis and ensuing recession would have made investors extra-cautious. But that's not the case, says Bart Chilton, a commissioner at the Commodity Futures Trading Commission and the author of Ponzimonium: How Scam Artists Are Ripping Off America. He says the weak economy has made people "willing to engage in much riskier behavior. There's a proliferation of the scams at exactly the time people are most vulnerable." (People who deal in alternative assets insist that abuses are minimal.)

Either way, investors should be careful. Here are three questions and warning signs to consider before making an alternative investment:

1. Any sales pitch that encourages people to go into debt or pull equity from their homes is a glaring red flag. Failure in such an investment can threaten an investor's house or retirement.

2. Beware of any suggestion that returns are guaranteed. "Nothing in reality is guaranteed, especially in finance," says Lori Schock, director of the SEC's office of investor education and advocacy. "I'm not sure these people even know they're taking greater risks. They're told they have guaranteed returns and just assume that that's safe. It's not."

3. One of the greatest challenges with alternative investments -- even legitimate ones -- can be ensuring that there will be ready buyers when you want to sell. Ask, and get in writing, how the asset can be sold and at what price. Many holders of alternative investments have tried to sell, only to discover that they are locked in or can't sell without incurring severe penalties. Says Chilton: "People find out they don't have access to their money when they need it the most."

This story is from the December 24, 2012 issue of Fortune.

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