If you invest in funds or ETFs, you already know that there is always risk involved. But are you taking too much risk? If so, you have a greater chance of suffering catastrophic losses and being taken out of the game for good. That spells a retirement working at Flippy Burger. No Bueno.
What follows are 4 examples of high-risk adventures that are not appropriate for most moderate risk investors who want to grow their money safely over the long-term:
1. Country Funds
Funds that buy stocks from only one country are called country funds. At times, a country’s stock market does really well. When that happens, the corresponding country fund takes off. There may be strong fundamental reasons for the local market doing well or it may be a result of speculation (or a combination of both). Regardless, you should stay clear.
Narrowly based country funds are fraught with danger for most investors. Take a look at two examples; Russia and China:
The country’s bubble can burst quickly as a result of economic, political or military instability. This Russian country fund lost 25% in 5 months in 2014. The Chinese country fund lost over 50% within a year. Their respective losses had different causes but they both demonstrate how volatile these kinds of funds can be. Believe it or not, a country fund can be more risky than an individual stock and I don’t even like those for most people.
Some funds buy raw material contracts for sugar, gold, coffee, copper etc. These are known as commodities funds. Some of these only buy contracts on one commodity and others buy contracts on a variety of commodities. People buy these funds when they think the underlying commodity is in short supply relative to demand. If the investors are right, the fund value will rise as the price of the underlying commodity goes up. I advise you to stay away from these funds on these investments too.
Even if you think you know the price of the commodity is going up the truth is you don’t really know. Of course you could make money on this play but it is pure speculation. Think about gold if you want a painful reminder.
Investors were bombarded for years with hype about how they could make a killing in gold. And many people did – until they didn’t. Gold dropped from around $1800 an ounce to less than $1300 in a very short time. Can you imagine what happened to the gold commodity funds? It was not pretty.
Industry funds can be slightly more diversified than commodity or country funds but not much. These are funds that only invest in companies belonging to a given industry. Examples include computer software, transportation, energy exploration etc. They suffer from the same problem the other two do– narrowly focused investments. The risks are too great – non merci!
4. New/Lightly Funded
If you hear about a fund that’s done really great make sure it’s established and well-funded. Sometimes it easier for new funds and ETFs to put up impressive numbers because they don’t have much money to invest and/or they don’t have a long track record to make up for.
Newbie funds often focus their assets in a small number of securities. If they get it right, the returns can be impressive. But what you want are funds with long-term track records. Look at the fund performance in good and bad years. That is a much better measure of what you are getting yourself involved in.
I love mutual funds and ETFs. They are an inexpensive way to have a widely diversified portfolio managed by the best people available. But not all mutual funds are alike. When you select your funds, look at past performance as well as the past. Stay away from narrowly based investments because your risk is much higher. Usually that risk is just not worth it.
What have been the riskiest funds you ever purchased? Did you do anything different as a result?