If another financial crisis happened, would you invest more? Do you like investing over keeping your money in a savings account? Are bitcoin and stock trends such as the GameStop saga that happened up your alley? If a “yes” floated through your head, then you probably have a high-risk tolerance when it comes to investing. This is not something to brag about, however. Yes, many people do have the investment approach of “no-risk, no-reward.” Some risky investments are not worth the possible rewards.
What is listed below as risky investments to “avoid,” doesn’t mean you should avoid all of them. It’s fine to consider investing a small amount in one or two over the course of your lifetime if you have a diversified portfolio. Even if this is the case, you should do research and weigh the costs and benefits. It’s also important to keep note of who or what depends on you. Yes, there is the chance that you will make money if things go in your favor. There is also the large chance things don’t go in your favor. If this is the case, the losses can be devastating. People have lost their entire investments as well as their livelihoods. Here is a list of some investments that you should generally avoid:
Most people are not rich enough or connected enough to invest in an IPO, or initial public offering. IPO’s actual offering price is very expensive and they are usually reserved for rich investors or company insiders. Many people are swayed and get excited when a company goes public. In other words, their shares can now be traded on the stock market. Many news companies cover this, so it’s easy to get caught up in the excitement. However, many times, initial share prices are overinflated as people are optimistic about the company and have hopes of buying into the next Apple or Amazon.
Don’t assume that a company is making profits just because they go public or have a high share price. Most companies that just go public have not made much money yet. In fact, after five years, around 60% of IPOs have negative total returns.
2. Penny Stocks
Penny stocks are cheap and for good reason. Their share price is so low–under five dollars–because they don’t have much history or any history of making a profit. Some have even encountered trouble where they are kicked off of a major stock exchange. Penny stocks are risky because they are hard to sell, especially during times when you really want out because you are losing money.
These stocks trade infrequently and because the issuing company is not very large, they are greatly influenced by good and bad pieces of news. In addition, fraud is very prevalent in penny stocks. Some people “pump and dump” where they spread false news about the company to jack up the price. This creates a buzz around the company and people buy into this false news and look to invest. The scammers then dump their shares on these unknowing investors, and these unknowing investors can lose everything. See more on penny stocks and potential good ones to invest in if one so chooses here.
3. Anything you have to buy on margin
The concept of buying on margin might seem like a positive thing to some, as buying on margin gives you more money to invest. You essentially borrow money from your broker by using the stocks you own as collateral. However, you have to pay your broker back, and with interest. If things all go well you can greatly increase your returns. However, when things do not go well, it can end very very badly. For example, if you buy $10,000 worth of stocks and then it drops by 50%, you would lose $5,000 normally. If you bought the stock with only $5000, and used margin to pay the other $5000, you would lose everything–not just $5000. You would have to use the remaining $5000 you have left to pay back your broker. And this is before interest is involved.
People who support and believe in bitcoin think that this cryptocurrency will eventually be the way we all pay for things. However, in the present moment, what you can actually pay for with bitcoin is very small. Until it is widespread, bitcoin will be a speculative investment.
Most people invest in it, not because they believe it will be widespread. They invest because think other people who invest in it will keep driving up the price. This kind of speculation causes great price fluctuations. For instance, at the end of 2017, bitcoin had peaked at nearly $20,000 a coin and then dramatically decreased in 2018 to below $4000 a coin. This kind of volatility does not make bitcoin sustainable as a form of payment or form of currency. Unless you are a person with loads of money and you can afford to lose a lot of your investment, you should not invest in bitcoin.
Many people collect things such as art, cards, cars, furniture, etc. Some people hope that their collections will turn into a profitable investment. There is no problem with spending money in order to create a collection of items or pieces because you take joy in it. However, if you believe or even hope that selling your collection will make you a profit, think again. Collectibles are illiquid assets which means that they are hard to sell.
Like penny stocks, investments that are hard to sell mean that they have a lot of risk. You might not be able to find a buyer in time that you need it most or you might have to sell the collection at a fraction of the price that you bought all of the pieces for. It’s difficult to put a value on a collection because there is no stock exchange for certain items like cars. In addition, if you do manage to sell your collection, you will have to pay 28% of what you make in taxes. Long-term stocks are only taxed at around 15%–a large difference. There is also the risk of you losing your collection in a fire or it getting stolen.
6. Leveraged ETFs
Investing in a leveraged ETF is like buying on margin but worse. Leveraged ETFs, or exchange-traded funds, give investors in the fund a bundle of investments that are supposed to follow a stock index. However, leveraged ETFs are different from regular ETFs in that they look to make two to three times the index that they are following. They are able to do this in ways that leave you with greater exposure which means more risk. A leveraged ETF that tried to earn three times the benchmark index’s returns is letting you invest $3 for every $1 invested.
If things go well, you can make a lot of money, but if things go south, your losses are amplified. Leveraged ETFs require you to rebalance each day to mirror what the underlying index is made up of. You can’t just let it work by itself and earn you money in the long-run. Every day, you basically have to invest in a different product with a leveraged ETF. For this reason, these only make sense for day traders, or day traders with lots of money who are able to sustain large losses.
7. Shares of a company that is bankrupt or about to become bankrupt
If a company declares bankruptcy, you can be left with no money. People who are shareholders are the last people on the list of who gets paid in this situation. Bondholders, owners of preferred stock, and secured creditors will all get paid before you (the common shareholder) get any money. Essentially, when a company declares bankruptcy, their stock prices crash. However, many people are eager to buy these very cheap shares. This temporarily drives up the prices of the shares. However, there is a large chance that these shares will go back down to $0 shortly after the fact. If you don’t buy and sell at the exact right time, you can lose a lot of money when the share price plummets to $0 again.
8. Junk Bonds
If you don’t have a high credit score, you will have to pay a high-interest rate when you borrow money. Many banks and lenders believe that there is a high chance you won’t pay them back which is the reason for the high rates. The same thing holds true for companies. When companies issue bonds, they do so because they need to take on debt. If there is a larger risk of the company defaulting, there will be more interest paid to the people who invest in these bonds. Junk bonds are bonds that have the highest risk of all of the bonds you can buy. If you own bonds in a company that filed for bankruptcy, you can lose everything. Bondholders don’t get anything until secured creditors–investors whose claim is backed by property such as a bank that holds a mortgage–get paid in full in bankruptcy court.
9. Options trading
Options give you the chance to buy or sell a stock at a certain price before a specific date. The right to buy is named a “call.” You usually buy a call when you think that a stock price will rise. The right to sell is called a “put.” You will buy a put when you think that a stock price will drop. Options trading is unique in that there is one winner and one loser. With other investments, you can sell and make a profit and the person you sold to can go on to sell and make a profit. This cycle can continue forever. However, if you buy a call or sell and you were correct, you get to buy a stock at a cheap price or you can offload a decreasing stock at a great price.
On the other hand, if you were not correct, you will lose all of the money you put into buying or selling the option. There is even more risk involved when you are the individual who has to sell the put or call. If you win, you can keep the entire amount that you were paid, but if you lose, you have to pay the high price for the stock that crashed or sell a stock that has greatly increased at a very low price.
10. Gold and silver
Many people are tempted to invest in gold and silver because they are told that they can use these metals to hedge against a bear market. If you are worried about high inflation or the stock market doing badly, you might think that this is a good option as gold and silver have held their value throughout time for the most part. In addition, when times are bad, many people look for tangible assets. It is a good thing to have a small amount invested in gold and silver because it can help to diversify your portfolio. However, investing more than 5% is very risky. Both of these precious metals are extremely volatile as gold is very rare so discovering a new source of gold can lower the price.
Silver is more volatile than gold because the value of its supply is much smaller. Both of these factors mean that a small change in price can have a large impact. Both also perform under the S&P 500 in the long term. The riskiest way to invest in gold and silver is to buy the physical metals themselves. Oftentimes, gold and silver are difficult to store and sell. An option with less risk is to buy a gold or silver ETF that has a wide variety of assets like physical metals and mining company stocks.
11. Subprime mortgages
You have probably heard of this term because of the 2008 financial crisis. If you are new to the term, however, subprime mortgages are essentially mortgages that are given to customers that have very low credit scores. This most likely means that these people will default on their loans. While these subprime mortgages do give investors higher interest rates, they come with a large amount of risk. Although lending regulations have tightened since the 2008 financial crisis in which these investments ended up worthless, subprime mortgages are still investments with low-rates and a high risk for default. Invest your money elsewhere.
There is no harm in putting a small amount of money into an investment with high-risk. However, you should be prepared to lose everything that you invested–something than many people don’t fully realize when they invest in one or many of the things listed above.