5 Investment Risks That Often Lose Money — and Investing Alternatives for Each
It’s only human nature for investors to want to earn as much money as they can in the shortest possible time. However, this desire for rapid, high returns runs often encourages investors to take outsized risks in speculative investments.
Unfortunately, what’s often overlooked by investors is how these very same instruments can also destroy wealth — often even faster than it is made. Here’s a look at common risky or bad investments that often get airtime but rarely are the right choice for long-term investors. For every poor choice, there’s an alternative option that can usually provide a much better risk-adjusted return.
Risky: Over-the-Counter Stocks
Over-the-counter stocks, also known as penny stocks, are unregistered securities that don’t trade on any stock exchange. As such, information about them can be hard to come by, and the market is easily prone to manipulation.
If you’re on the right side of this, sure, you can bag great returns in a short period of time. But the odds of that are very small, and most OTC stocks live on hopes and dreams rather than actual financials. You can liken picking OTC stocks to gambling in a casino.
Better Option: Fractional Shares
If the reason you’re attracted to penny stocks is their low price, you no longer have to use that as an excuse. Many brokerage firms now allow the purchase of fractional shares of stock. This means that even if you only have $100 to invest but want to buy a stock at $150 per share, for example, you can now simply buy 0.67 shares.
Although there are no guarantees that your individual stock will go up in value, at least you’ll be able to make an informed decision about it. If you want a more diversified approach, you can buy fractional shares of a broad market fund, like an S&P 500 index fund.
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Crypto has always had its naysayers, with many experts saying it was built on nothing of substance and destined to crash. In 2022, the markets lent much credence to this concept, as major cryptocurrencies fell more than 50% and some smaller ones essentially vanished.
While some argue that this is merely a “crypto winter” and that the major cryptocurrencies will recover, that’s a speculative argument based on not much more than belief. Unlike the stock market, which bases its value on real-world earnings and revenues, cryptocurrency is only held up by the belief that it will someday replace, or at least coexist on equal footing, with fiat currencies.
Better Option: Alternative Investments
If you’re looking for the thrill of a “frontier-type” investment but want to avoid cryptocurrency, consider alternative investments. These can include anything from commodities like oil and pork bellies to private equity shares or collectibles like fine art, wine or trading cards.
These types of investments can be cyclical and highly volatile, but they have intrinsic value that cryptocurrency currently lacks.
Risky: Meme Stocks
Meme stocks may seem to be “more legitimate” than penny stocks, but they trade in a similar fashion. Typically, meme stocks are unloved, heavily shorted companies that have real-world financial problems, but they can rapidly gain momentum based on the recommendations of short-term traders on financial message boards.
As that type of support may vanish at any time, it’s speculative at best to consider these types of stocks, which have recently included GameStop, AMC and Bed Bath & Beyond.
Better Option: Aggressive Growth Stocks
Aggressive growth stocks can share some of the high-risk/high-reward characteristics of meme stocks, but they are fundamentally different.
While you shouldn’t put all of your money into aggressive stocks unless you have a very high risk tolerance, a diversified portfolio that includes some high-octane stocks can boost your long-term returns, with careful research.
Risky: Leveraged ETFs
Leveraged ETFs offer the opportunity to earn 2x or even 3x the return of an underlying investment, such as the return of the S&P 500 index. Although perhaps sounding good on paper, these instruments are meant for short-term traders only.
Structurally, the way leveraged ETFs work, their value decays over the long run, making them potentially useful for short-term trading but bad ideas for long-term holders.
Better Option: Straight Investments
If you’re feeling really bullish on an investment, simply buy more of it. Rather than leveraging yourself through an arcane, complicated investment, simply add to positions you believe in.
Remember that if you buy a 3x leveraged ETF and you are wrong, a market dip of 16-17% will leave you 50% in the hole — and that will require a 100% return just to break you even.
Risky: Junk Bonds
Junk bonds have their name for a reason. Occupying the rungs below “investment grade” bonds, even professional mutual funds or pension funds are usually restricted from buying them.
Although professional bond traders may use them to boost their returns, individual investors generally don’t have the insight to pick the right winners. And even if you do, the few extra percentage points you might earn aren’t likely worth the risk.
Better Option: Investment-Grade Bonds or Preferred Stocks
For just a slight cut in income, you can invest in bonds or preferred stocks from higher-rated companies instead of junk issuers. In exchange, you’ll significantly reduce the risk of suffering default.
You’ll still have to deal with other risks associated with this type of investment, such as interest rate risk and inflation risk, but you’ll more likely than not receive your interest and principal payments over the long run.
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