Good financial advisors help investors steer their savings toward reliable investments. These securities may not offer spectacular rates of return, but they do offer what most investors want: A reliable way to generate more money without much interference or insider knowledge.
You’ve probably heard the saying, “Scared money doesn’t make money.” A more pragmatic take on this might be, “If you have any fear about losing money on the following investments, choose more conservative financial products.” It’s not as catchy, but it’s just as useful. Irresponsible brokers might present these high-risk investments as exciting opportunities to hit the jackpot. But just like winning the lottery, winning big on a risky, hot-ticket security is extremely unlikely.
1. Brokered CDs vs. Certificates of Deposit
With a bank CD, the interest compounds automatically. Investors have to invest the interest from brokered CDs themselves, making them less ideal for investors who want a hands-off approach. It’s also possible to trade brokered CDs, but that trade might come with a substantial fee.
Brokered CDs are provided through brokerages but issued by banks. This is part of what makes brokered CDs so easy to confuse with traditional certificates of deposit — it’s possible to buy a brokered security from someone who works at the bank, just like a regular Certificate of Deposit.
2. Variable Annuities vs. Fixed Annuities
Investors purchase annuities so that their investment can earn tax-deferred interest. Fixed annuities accrue interest at a set rate — often the brokerage will guarantee a minimum rate. For investors nearing or in retirement, fixed annuities offer a better interest rate than a simple savings account and come with the promise of reliable payouts down the road.
Variable annuities (VAs) depend on the stock market, which makes it easy for them to lose money. As usual, this higher-risk scenario comes with the chance for higher returns. But because of their complex nature, it’s difficult for investors to know if their investment has paid off. One survey showed that one-third of registered investment advisers would not recommend annuities to clients, due in part to their cost and their complexities. The high commissions for brokers who manage to sell them may explain why they’re popular.
3. UITs, Mutual Funds, and Closed- End Funds
Unit Investment Trusts, mutual funds, and closed-end funds are all different types of investment companies. They have underlying security portfolios that could be made up of stocks, bonds, or debt instruments. Their performance depends on the market for those securities.
These financial products are not always predictable and cannot always guarantee a reliable rate of return. Investors might hear about a “hot” mutual fund, but they should keep in mind: a fund’s past performance does not indicate how well it will perform in the future.
To be clear, these all could be solid investments, it’s just not easy for a novice investor to assess their worthiness.
4. Real Estate Investment Trust (REIT)
REITs are companies that seek to make money off of income-producing real estate. An example of income-producing real estate would be an apartment building, a storage facility, or a hotel. Investors who buy REITs own a stake in the property, the same way buying a stock gives an investor a stake in a company.
REITs often look like attractive investments because they are required to pay 90% of their annual income as shareholder dividends, meaning they can offer a steady stream of payouts. But as we’ve seen with COVID-19, unpredictable factors can affect rent collection. While many tenants struggle to pay their rent, the Wall Street Journal reports that REIT stock prices lost 23% in 2020. Once again, investors need to carefully evaluate their risk tolerance before purchasing a REIT.
5. Exchange-Traded Fund (ETF)
ETFs are bundles of securities, similar to mutual funds. They may appeal to investors because they charge lower fees and are more tax efficient than mutual funds. Investors need to know exactly what’s underlying their ETF investment. ETFs might be made up of extremely volatile stocks, like a commodity ETF that invests in crude oil, or something quite stable, like a government bond ETF.
Some types of ETFs are highly speculative and risky, like inverse ETFs.
Inverse ETFs allow investors to bet against a market. These types of funds are based on options or commodity futures. With an inverse ETF, as the options or commodity futures decrease in value, the value of the security increases.
- Options give investors the right to trade a security at some point in the future. The investor purchases an option in the hope that the security will have increased in value by the time they’re ready to place the trade.
- Commodity futures are contracts that agree to pay a certain price for a commodity (like gold or oil) at a later date, based on the speculation that this will lock in a good price.
- Inverse ETFs can be leveraged, which helps increase the potential payoff if the underlying securities drop in price.
Leveraged ETFs give investors the chance to make double or triple daily returns but can lose just as much money as they have the potential to gain. It all depends on how the underlying portfolio performs. These types of ETFs require daily re-balancing, which can incur significant fees.
This is another type of ETF that hints at the possibility of a good return, but probably presents too much risk for it to be worth a smaller investor’s time.
6. Penny Stocks
“Penny stocks” trade for less than $5 per share and offer tiny stakes in small companies. These stocks are the source of exciting stories about investors who buy cheap stocks, forget about them, and then become millionaires overnight.
Recently, the SEC introduced a new rule to stop brokers from selling penny stocks from companies that don’t release their financials. The Wall Street Journal reports that the SEC did this in order to stymie the swindlers who “stir up a buying frenzy,” only to sell their penny stocks, resulting in a price crash. Hopefully, this latest move by the SEC will reduce the number of BrokerCheck complaints that involve these types of stocks.
The Bottom Line
Unfortunately, financial advisors may recommend high-risk investments solely for the sake of earning a big commission for themselves. The Financial Industry Regulatory Authority (FINRA) has rules meant to curtail this behavior, and investors who feel misled by their broker or investment adviser should seek the assistance of a securities attorney.
If you feel your broker recommended an investment strategy that was unsuitably high risk, do not hesitate to contact our law office for a free and confidential consultation, at (877) 238-4175 or email@example.com.