19 November 2017

Five Popular-but Dangerous-Investments for Individuals

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Many investors have sought out alternatives to mutual funds in hopes of seeking protection from perceived market dangers. But many of these alternatives lack transparency, are expensive, and don’t have a proven track record. Here is what you need to know about the five investments—and some safer alternatives.    

Liquid-Alternative Funds  

"Liquid alternative" mutual funds typically employ hedge-fund-like strategies but don't come with the same restrictions. There isn't a high investment minimum, for example, and the funds aren't as difficult to exit as traditional hedge funds. But skeptics say the strategies often are too complicated for the average investor to understand, and many are too new to have a proven track record.  

Try instead: If you want some shelter from the risk of a bad decline in stocks, you could always keep more of your money in cash instead. It is safer and a lot cheaper. 

Nontraded Real-Estate Investment Trusts 

Nontraded real-estate investment trusts are similar to their public counterparts, which trade like stocks and allow investors to invest in an array of commercial properties. The investments have become a concern of the Financial Industry Regulatory Authority, the industry's self-regulator. Because they are generally illiquid, their performance and value are difficult to understand and the cost is high, the agency has warned.  

Try instead: Publicly traded REITs aren't nearly as risky and are far more transparent, and they can be a good diversifier in a portfolio. A mutual fund that holds a basket of commercial real-estate companies also can provide exposure to the market and is liquid. 

Leveraged and Inverse Exchange-Traded Funds 

Leveraged ETFs are designed to provide investors with a certain percentage return over the movement of a market over the span of a day. Inverse funds are supposed to move in the opposite direction of a specific index, to provide protection against declines. Many of these ETFs use "total return swaps"—a complicated financial agreement that allows a fund to take on leverage to boost returns. That adds a "counterparty" risk if the investment bank issuing the swap goes bust, Mr. Nadig says.  

Try instead: If you want to make a strong bet on stocks you can invest in small stocks with a greater potential upside. 

Structured Notes

Structured notes are debt instruments whose returns depend on the price movements of other assets, such as stocks, currency exchange rates or commodities. A recent survey of 700 financial advisers sponsored by New York-based Exceed Investments found that complexity and liquidity issues were the main reason why financial advisers weren't offering them to clients.  

Try instead: If you are looking to hedge against market risk, rebalance your portfolio by increasing exposure to conventional bonds while decreasing exposure to stocks. 

Unconstrained Bond Funds

Fund companies not pushing liquid-alternative funds are often pitching "unconstrained" bond funds, also known as "go anywhere" funds. The category has seen massive inflows as investors worry that traditional bond funds will suffer from rising interest rates. Theoretically, they are supposed to make money and limit risk, even in a bond-market downturn. But those gains are coming from riskier investments. In their push for returns, many investors don't understand the risks, says Eric Jacobson, an analyst at Morningstar. 

Try instead: If you don't want to take on additional credit risk but you want to lower your interest-rate risk, a short-term bond fund is an alternative. 

 

 

Click here for the full article from The Wall Street Journal. 

 

 

 

 

 

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