6 Investments to Avoid Like the Plague
It was no surprise that Adam McKay’s brilliant film, The Big Short, received the recognition it did this awards season. He was able to peel away the complicated layers that caused the 2008 housing crises, and finally explain these investments in a way people can understand. Watching Selena Gomez explain credit derivatives was shocking and eye opening all at the same time. An industry full of individuals of average intelligence were able to create products that are so complicated and difficult to understand that the only way one could possibly focus on it was by watching an international pop star in a see-through top explain it.
The movie was a sobering reminder that even though this country is 7 years out of the gutter with the S&P having tripled since it’s lowest point, Millennial investors have to be smarter this time around. They have to do quite a bit of research to avoid investments that are not appropriate for themselves and their lifestyle.
The 6 investments that Millennials should avoid
Fund of Funds
A fund of funds is an investment strategy of holding a portfolio of other investment funds. Many believe the reason they exist is a weak and lazy attempt at diversification. A fund of funds has too many layers, and it is likely very difficult for the fund manager to do the proper due diligence of every security that is held under every fund that their fund owns.
Human nature has a strange way of creeping in and repeating itself. Knowing full well that no investor is reviewing the hundreds or thousands of securities that make up the layers of a fund-of-fund, it may make it too easy for a manager, somewhere along the way, to make an unkosher move, or take his or her eye off the ball.
Furthermore, there are sales charges and expense ratios eating away at performance every step of the way. An investor may not know about these charges unless they did an extensive amount of their own research.
A long short fund invests in companies by betting that they go up AND that they go down. This way, if they go up, you will not lose too much money, but if they go down, you will not lose too much money either. The problem with long/short funds is that they hardly have any performance at all. No direction that the market goes is a great direction.
A long/short fund can make a few percent per year, but if that is what you are seeking as an investor, there are other ways to invest conservatively, and get more reliable performance. For example, there may be bonds that could likely make more money over a period of a time than a long/short fund could potentially make. There are also options strategies that could protect a stock investment to a certain extent, which could potentially give an investor a much higher return.
In most cases, Millennials should have some appetite for risk, and a long short fund likely has too little upside for a long-term investment strategy.
Retail Mutual Funds
A mutual fund is a pool of funds that is managed by a money manager. In the right funds and in the right situation, mutual funds can be an excellent way to get exposure to a specific market in a strategic way. There are some incredible mutual fund managers out there, but it is important to pick the right share class for you.
Mutual funds are broken down into different share classes. There are retail share classes (usually described as class A, B, or C) and institutional share classes. Retail share classes charge a “load” which is a sales charge that you pay either when you buy or sell the fund. Sales charges are the fees that you should avoid. Institutional shares are shares that are sold in larger quantities, usually to larger institutions. If you have an account with a bank, you should have access to this share class, even if you are investing in small quantities.
Institutional share classes have a charge as well, called an “expense ratio”, but it is usually cheaper to invest in an institutional share class, rather than a retail share class.
TIPS (Treasury Inflation Protected Securities) are a way to invest in US Government bonds, while protecting yourself against inflation. First of all, our inflation rate is so incredibly low, that there is virtually no inflation to protect yourself against. Secondly, US Government Bonds, while being one of the most secure investments other than cash, pay investors unbelievably low yields. Overall, we believe TIPS make no sense to invest in during this current environment because they have no real potential upside, but do have some downside risk from the inflation hedge.
ETF stands for exchange traded funds. An ETF is simply a bundle of stocks, bonds, or other financial product that is grouped together and traded like a single stock.
Leveraged ETFs are magnified ETFs. They give you enhanced exposure to a specific investment. Any ETF that says 2X or 3X next to it is leveraged. For example, if you were to buy a leveraged ETF that represents the S&P Index, and the S&P went up by 1%, you would gain 2%. On the other hand, if the S&P went down by 1%, you would lose 2%. A leveraged ETF is like doubling down in blackjack after only seeing your first card. For most investors, it is just too risky and too volatile a product, unless you have an incredible risk appetite, or are using the leveraged ETF as a day trading tool.
Your House As An Investment
We grew up learning that a house is your biggest asset. It’s not. A house can be a good purchase, because you are buying a place to live, but it is not actually a good investment. A good investment should make you money. A house is a liability. Generally, money constantly needs to go into it, and in the end, it may not appreciate beyond the amount of money you put into it. After ten years of mortgage interest, insurance, property taxes, and maintenance, you would have likely put more than 50% of the price of your home into expenses that have not built you equity. The national average of home price increases over 10 years is 25%, so even if your home appreciates, it will likely not appreciate enough to be viewed as an investment.
Please note that we are not suggesting that you do not buy a home. We are simply suggesting that a home may not be an investment and a way to make money.