You work hard for you money (or should I say bacon), and you deserve to have it protected. Investing is a way to protect and produce income, but also a way to lose it. With that said, I have some good news and some bad news.
The bad news is that there are no get-rich-quick schemes when it comes to investing. As much as many people would like there to be some magical way to accumulate wealth in a short period of time, it simply does not exist. This may lead people to believe that the opposite must hold true too; that there is no way to lose substantial amounts of money in a short period of time, right? Unfortunately, if investors like you and I aren’t careful, it can be very easy to put our hard earned money at risk.
The good news is that below, I discuss and explain the inner workings of some of the riskiest investments that are available to investors – and why you should avoid them.
Risky Investment #1: Penny Stocks
What are they?
Penny stocks are similar in nature to regular stocks in the sense that they represent ownership of an organization. The main distinction between penny stocks and regular stocks (for example Google or Apple stock) is that they are traded and offered to investors at extremely low prices, often less than one dollar. Hence the name.
Offering shares at such low prices often attracts investors by marketing the fact that with a small investment, they can own tens of thousands of shares. Sounds great right? If someone offered me 1000 shares of a company, I would’ve thought that I’d won big! Wrong.
Why are they risky?
Penny stocks carry a high degree of risk because their prices are extremely volatile. This means it is very hard for individual investors, no matter how much they think they know, to predict whether the stock will go up, down or keep the same value.
Companies offering shares at extremely low prices are often newer, smaller companies, that look to attract capital from uninformed and uneducated investors. Sometimes these companies don’t even meet the requirements to be listed on a major stock exchange such as the Toronto Stock Exchange (TSX).
Given that many companies offering penny stocks are new, there is not a lot of information about these organizations. Sometimes they don’t even show up on a simple Google Search. This makes predicting price movements even harder. With such little information available regarding a company’s’ financials, business strategy, sales projections etc. it becomes harder and harder to understand what price you should be paying for part ownership.
The last of the major downsides with owning penny stocks is the near impossibility of getting your money back. This is otherwise known as liquidity – or just straight up cash. Basically, if you’ve bought penny stocks and wish to sell them (after you’ve realized you’ve made a terrible mistake), you may have a hard time finding somebody to buy them. There isn’t a large market for buying and selling penny stocks, and the fact that not many people invest in penny stocks should tell you something… This leaves you with your cash tied up in a highly unpredictable and risky investment.
Risky Investment #2: Commodities
What are they?
Commodities refer to raw materials that are extracted from the earth and are manufactured and produced for sale. While the most widely traded commodities include oil, gold, natural gas and lumber, other raw materials such as fish, silver, salt, sugar, rice, wheat and coffee are also traded around the world in financial markets. Civilizations have been using commodities for hundreds of years as a form of currency, although only relatively recently has the concept of trading commodities for financial gain become mainstream. In today’s market, investors trade commodities in large volumes, hoping to capitalize on marginal (very small) price movements of resources such as silver, gold and oil.
Why are they risky?
For many years, investors have included commodities as a major part of their financial portfolios. Many commodities are traded in extremely high volumes on a daily basis. But the primary reason that commodities carry such a large amount of risk is that investors are essentially betting on the price of a good to go up, rather than investing in an income-generating asset, such as a dividend-paying stock or a bond. With other stocks, you simply earn money by keeping your share in that company through regularly paid dividends, regardless of whether the price of that stock goes up or down.
Commodities offer investors no dividends. They are heavily exposed to a number of factors that can cause decline in the value of the commodity and to an increase its volatility (unpredictability). These factors include global supply and demand dynamics, political unrest (which you’ll find to be particularly true when analyzing oil and oil-based commodities) and advancements in global technology. I mean, how much longer are we going to use paper instead of online forms?
Lastly, similar to penny stocks, there is not as much information about commodities compared to other financial assets such as stocks, ETF’s and bonds. This makes it increasingly difficult for investors to understand or predict price movements of commodities.
TLDR: just understand that investing in commodities is more like betting than making a stable, long-term investment… and what would you rather do, watch $5,000 grow to $20,000 over the course of your lifetime or gamble $5,000 at a black jack table? Your call.
Risky Investment #3: Futures and Options
What are they?
Futures and options are contracts (or agreements) between two parties in which one party essentially bets on the price of a stock or commodity going up or down after a certain period of time. The other party “takes” that bet, hoping for the opposite. Notice the word bet here? In general, investors find futures and options to be a confusing and complicated financial tool – and for good reason. They're a bit sneaky.
Why are they risky?
Investing in futures and options is essentially gambling. There is a school of thought that claims that you can accurately predict the direction of a price movement by using complicated formulas, algorithms, and supercomputers. But even if this were true (and check out this article to see what the Harvard Business Review thinks of predicting stock market moves) one would need the time, money and most of all the lightning-fast equipment that simply is not available to the vast majority of the population.
The growing complexity of these (evil) financial instruments, not to mention the incredible swings in prices of these contracts makes it even harder for investors to gain any value from them. But since banks and financial institutions continue to reap the benefits of charging fees to sell futures and options, don’t expect them to disappear anytime soon. My advice? Stay far, far away.
Risky Investment #4: Equity Crowdfunding
What is it?
Equity crowdfunding is not regular crowdfunding. What most people refer to as crowdfunding through platforms like Kickstarter, are ways to donate your money in return for a gizmo, gadget or a very sincere thank-you. Equity crowdfunding means you invest in a company in exchange for a portion of ownership – just like buying regular stocks. The difference between purchasing regular stock and equity crowdfunding, is that companies raising money through equity crowdfunding are not publicly listed yet. Going public is extremely expensive and is designed for more mature companies. Unlike publicly owned companies, smaller and newer startups offer equity crowdfunding through specialized platforms like GoTroo and InvestX. Those platforms give a chance for regular investors like you and I to buy shares in companies before they get very big.
Why is it risky?
Since companies seeking equity crowdfunding aren’t publicly listed yet, you cannot sell your shares until the company is large enough to go public. This means your money could get tied up for a very long time if the company doesn’t grow fast enough. It could also mean your money is lost forever if the company dies. There is no guarantee of any company’s long-term success, but we do know that 90% of start-ups fail. By investing in these companies, you are betting on your company belonging to the 10% that don’t fail rather than investing in something with a proven track-record.
With all of this in mind, equity crowdfunding is regulated by provincial governments. In almost all provinces (except Ontario, Alberta, PEI and the territories), everyday investors like you and I are only allowed to invest up to $1500 per year in equity crowdfunding. Companies too, are only allowed to raise money through this avenue twice a year.
While equity crowdfunding has made it easier for start-ups and entrepreneurs to raise capital, it has also presented the market and investors with extremely risky investment opportunities that put your money at risk. So, be warned…
Everything I’ve discussed until now has explained how not to invest. So what are some benchmarks to keep in mind of things to do? Here are 5 key pieces of advice you can follow to minimize your risk and protect your hard earned bacon – money!
Tip #1: Diversify
This word can be captured by one of the oldest phrases in the book, “Don’t put all your eggs in one basket.” Similar to the fact that you wouldn’t go all-in on the first black-jack hand you’re dealt (or maybe you would but if so, that’s a whole different issue) you wouldn’t invest all your money in one place.
To diversify your investments simply means to spread out your money amongst multiple investments. This could mean balancing your portfolio with stocks and bonds or perhaps investing in more than one industry instead of only technology.
Tip #2: Don’t invest in what you don’t know
Does this mean you have to know exactly where every dollar invested is? Absolutely not.
As an investor, no matter if you have $100 or $100 million to invest, whether you manage your own money or you pay a financial advisor, it is your responsibility to know where and how your money is invested.
Knowing some basic information about your financial investments including what asset classes you are invested in (stocks, bonds, GIC’s etc.), your long-term objectives and what fees you are paying will ensure you are not taken advantage of by the Big Brother-esque system we call financial markets.
Tip #3: Avoid “Get Rich Quick” Schemes
These just simply do not and will not ever work.
Tip #4: Keep yourself educated and up to date
The more knowledgeable you are about your investments, your financial goals and your personality (yes, this plays a big role, believe it or not) the better prepared you will be to effectively manage your finances.
Keep yourself educated about world events and trends in the marketplace that can affect your investments. By keeping up to date with global news you will better understand why your money is growing…or not. Also, be sure to keep track of any fees you may be paying your financial advisor or mutual fund company because you’re probably paying more that you think. (Don’t believe me? Check out this article)