August 17, 2011
In these white-knuckle days, when even the safe bets are subject to scrutiny, it pays investors to be doubly cautious. From penny stocks to the latest IPOs, here are some investments that are almost guaranteed to lose you money, according to financial experts.
1. Leveraged ETFs. They were all the rage a few years ago, but these special ETFs (exchange-traded funds) have the dubious honor of ranking No. 1 on the list of poor investments. Don’t know what they are? Good, because “they destroy portfolios,” says Pat Dorsey, director of equity research at Sanibel Captiva Trust in Sanibel, Fla. Like regular ETFs, leveraged ETFs track the returns of a specific index fund, but they promise returns whether the market goes up or down. Actually, leveraged ETFs are for day-trader types and are vulnerable to price changes throughout the day. “They’re not designed for the long-term,” agrees Praveen Puri, vice president at Bank of America Merrill Lynch in Chicago. “These ETFs suffer from a narrow focus, high leverage, misleading labeling, and tax inefficiency.”
If you buy and hold these funds, the big losing days cancel out the big winning days, and the costs of rolling over expiring derivatives eat up any remaining return,” Puri explains.“If the timing’s not perfect, you get a different experience than you expect,” Dorsey says.
2. Airlines. “There’s no reason on God’s green earth to invest in airlines,” Dorsey says. At the end of the day, it’s a commodity. There’s no control over input costs. How do you become a millionaire? Start as a billionaire, and then buy an airline, Dorsey says.
3. EE Savings Bonds. These used to be the go-to gifts for kids. “Those days are gone,” says Scott Stratton, a financial advisor with GS Wealth Management in Dallas. The current yield is 1.1 percent. Stratton recommends looking into stocks such as Johnson & Johnson, which increased dividends 49 years in a row.
4. 10-year Treasury bonds. These bonds hit a record low last week. “They’re terrible long-term choices,” Stratton says. "The Fed has pledged to keep rates low through 2013, which means real savings rates will be negative.” Stratton says. “The 10-year Treasury priced a record low last week, with a yield of 2.14 percent.”
5. Buying a house beyond your means. Owning your own home has always been the American dream, but too many homeowners now wake up screaming. “People are thinking about cashing in their 401ks to pay for their mortgages,” Stratton says. You may want to buy your own house, but if you can’t pay for it, it’ll never be a good investment. Do your homework (think property taxes, maintenance, for starters) before buying into the dream. Just because you qualify for a $500,000 house doesn’t mean you should buy it, Stratton points out.
6. Hedge funds. One of the greatest appeals of hedge funds is their exclusivity. There’s the sex appeal of needing to be “in the club” in order to invest. “Hedge funds are illiquid, expensive, and often very risky,” says Allan Roth, founder of Wealth Logic, an investment advisory and financial planning firm in Colorado Springs, Colo. “They are a great way of transferring wealth from the investor to the hedge fund manager.”
7. Penny stocks. Penny stocks are common shares of small companies that trade for less than a dollar. You’re probably better off rolling up those pennies and heading to the bank. “It’s a shell game,” Roth says. The artificial inflation is classic “pump and dump,” he says.
8. Annuities in tax-deferred IRAs. IRAs are options for self-employed people or for those who don’t have access to a corporate 401k. One option is to put annuities, which are tax-deferred products that generally provide a regular stream of income at a later date, inside your IRA. However, IRAs are already tax-deferred. This is comparable to paying extra for the caffeine in your coffee. Financial planners make a fortune on these, says Roth.
9. New Internet IPOs. While LinkedIn, Groupon, and Pandora are attracting a lot of publicity, there’s no competitive advantage to these particular Internet companies, unlike Google, for example, according to Puri. Pandora’s stock has dropped significantly from its $26 high in June.
10. Futures in commodities and currencies. These are terrible investments because they involve leverage. People get interested in these trading areas because they calculate the possibilities of making a large return in a small amount of time, Puri explains. “This leverage is the critical factor with futures trading,” Puri says. “This ability to make a lot of money fast is what attracts people to futures, but it has also been the cause of many bankruptcies, divorces, and suicides.” Scott Stratton at GS Wealth Management in Dallas agrees: “They’re only for day traders.”