Investing is a game of risk. No matter what the economy looks like and what you invest in, it will always involve some uncertainty. Taking that leap can result in big wins in some cases, but some investments are too risky to be worth your time.
There’s a lot of financial noise out there, including plenty of promises that may sound too good to be true. To help you separate the noise from the real opportunities, here are five types of investing to avoid and five alternatives to try instead.
Investments to avoid and alternatives that are worth it
1. Penny Stocks
A penny stock costs $5 or less per share, although some people consider them less than $3 or even $1. These small company stocks look promising at first glance because they are so cheap. If it only costs you a few dollars to invest, what is the risk?
The problems arise when you stop and wonder why these stocks are so affordable. The companies behind them often lose money quickly and try to sell the business before it’s too late.
Penny stocks are a favorite “pump-and-dump” scheme, where people promote an investment to drive up its price before selling all of their shares at a profit. Other shareholders will convince you to invest in the next Amazon, then dump their shares when the price crashes. These schemes and instances of fraud are so common with these investments that the The Securities and Exchange Commission has issued warnings about them.
Alternative: savings accounts
Consider a savings account if you like the little you need to invest in a penny stock but don’t want to take the risk. Opening a bank account is a much less glamorous option, but it’s just as affordable and carries far less risk.
Savings accounts are more regulated than penny stocks, like FDIC insurance, so fraud is less of a concern. They are also quite resilient to macroeconomic changes, and although some accounts have minimum sizes, you don’t need to put much into them. You’ll make money from the interest rates, which are often low, but holding these accounts for a long time can lead to comfortable savings.
Savings account returns are too low to be your only investment option, but they are a good way to expand your portfolio. If nothing else, they’re an easy and safe way to create cash to fall back on when times get tough.
Timeshare is another investment that may seem too good to be true at first, and it often is. In these setups, you’ll buy partial ownership of a property like a vacation home in exchange for a set amount of time, usually one week per year, that you can stay there. It sounds like an affordable way to get your dream vacation property, but it’s usually not worth it.
When you take into account the price you pay for the little use of the property, you will quickly find that it is better to get the complete property at market price. Because you only effectively own it for a week, renting it out while you’re away is also tricky.
Despite what a presenter might tell you, timeshare depreciates faster than a new car, so owning one has little long-term value. You may also find yourself locked into a contract with maintenance and upkeep fees that the presentation didn’t tell you about.
Alternative: Rental housing
Investing in rental housing is a safer and more convenient way to access real estate. If you want the closest thing to what a timeshare promises, you can finance a home and rent it out as an Airbnb or similar setup when you’re not using it. Alternatively, you can invest in an apartment complex.
Rental housing gives you ongoing payments in the form of rent that would be hard to match with a timeshare that you co-own with several other people. These rents could also help pay off the property sooner and without high upfront costs.
3. High yield bonds
High yield bonds may seem tempting at first, mainly because of their name. “High yield” certainly sounds promising, but their older term, “junk bonds,” may be more accurate.
The high return on these investments comes from their high interest rates. They pay more than some other bonds, but that’s because they’re inherently riskier. These bonds typically come from companies with poor credit ratings, which suggests they are less likely to repay their debts on time.
Not all high yield bonds represent a doomed business, but it can be difficult to judge that from an outside perspective. Given the impact of bankruptcy on you as an investor, it is best to avoid these obligations.
Alternative: Real Estate Investment Trusts
One of the best alternatives to high yield bonds is a real estate investment trust (REIT). A REIT is a company that owns income-producing real estate, often specializing in one type, such as office buildings or apartment complexes. When you invest in these companies, you earn a huge share of the profits from these properties.
REITs must pay at least 90% of their taxable income to shareholders. You could see impressive returns in the right scenario, which could be what drew you to high yield bonds. However, unlike these bonds, REITs offer more security because they are liquid.
Some REITs have a low barrier to entry, which makes them easy to invest in. They also offer a way to capitalize on real estate without having to manage it yourself, which can be useful for first-time investors.
Another type of investment you’ve probably heard a lot about lately is cryptocurrency. Although relatively new, crypto has exploded in popularity over the past few years, attracting a lot of investor interest, especially if you’re looking for something unusual to diversify your portfolio. However, as you may have noticed in recent news, crypto is extremely volatile.
Currencies like Bitcoin have seen massive growth at times, but their crashes are just as huge. Crypto is also prone to hacking and scams, thanks to its relative novelty and digital nature. Cryptocurrency regulations are also constantly changing, making it difficult to understand where it stands legally.
A much smaller supply than other investment types means changes in demand have a much bigger impact on crypto than other opportunities. Sometimes that means skyrocketing growth, but you can see values dropping in others.
Alternative: Crypto ETF or Blockchain
Despite its issues, crypto and its underlying technology, blockchain, may see increased adoption in the future. If you want to capitalize on this potential but don’t want the risks of owning cryptocurrency, you can invest in a related exchange-traded fund (ETF).
Crypto and blockchain ETFs work like conventional ETFs: you invest in a group of companies that own those assets instead of the assets themselves. Therefore, when crypto performs well, your investments will too, but you will have more diversification to mitigate the impact of poor performance.
Some crypto ETFs track the general market performance of major cryptocurrencies, while others focus on a more specific group. Blockchain ETFs track companies producing blockchain technologies, which may not experience dramatic growth like some cryptos but are less volatile.
5. Consumer Discretionary Companies
One investment class that may not stand out as risky is consumer discretionary stocks. These are stocks of companies that offer non-essential goods and services, such as automakers, entertainment companies and restaurants. These aren’t as risky in nature as some others on this list, but they are subject to big swings in response to the wider economy.
These stocks boom when the economy is strong, but as it contracts and consumers spend less, their value can fall. Think about how airlines lost $168 billion in 2020 as the COVID-19 pandemic developed.
It should be noted that prudent investment in certain consumer discretionary companies can yield significant benefits. However, since these investments are highly dependent on the overall economy, they are not the safest assets, especially for new investors. The future is uncertain, so you might want to temper your expectations of these actions.
Alternative: basic consumption
Try commodities if you want to invest in consumer goods and services but want more security. These assets are the opposite of consumer discretionary companies. These are businesses that people will always buy from, such as food and beverage retailers, medical supply companies, and personal care products.
Admittedly, these investments will not reach the same heights as consumer discretionary companies during an economic boom. However, they will not exhibit the same decline in times of financial uncertainty.
Consumer spending represents 70% of the US economy, so investing in the sector is a good idea. Opting for commodities rather than discretionary companies gives you a safer way to do this.
Investing can be daunting, especially when so many initially promising assets can quickly turn sour. However, if you know what to look for and what to watch out for, you can make smarter and safer decisions about where your money goes.
Each specific asset is different, but these five types of investing are often too risky for most investors. If you want to get the most out of your money, try the alternatives listed here instead. You can then get similar benefits with less risk.
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