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Canadian MoneySaver http://www.canadianmoneysaver.ca SEPTEMBER 2008 Investment Products To Avoid (Part 1) The choice of investment products available in the Canadian financial marketplace today is truly staggering. Retail investors can buy stocks, bonds, income trusts, options, mutual funds, exchange-traded funds, gold, mortgages and hedge funds, to mention just some of the investments available at the click of a mouse. Notice I used the word buy, not invest. In my opinion, there are many types of investments which do not belong in the portfolio of the average retail investor. In this article I'll discuss, in no particular order, half a dozen types of investments that I don't buy and I think that most retail investors should avoid. In a follow-up article, I'll continue with this theme. And yes, there are some types of investments that I do buy. I'll reveal these at the end of the article. Labour Sponsored Investment Funds (LSIFS) Labour Sponsored Investment Funds (LSIFs) are corporations that invest in promising small and micro-cap Canadian companies. Investors have traditionally bought these funds for the generous tax credits offered by the federal and provincial governments. This is the wrong reason to invest. Your investment decisions should be based on the merit of the investment itself. Any associated tax relief should be considered a fortuitous bonus. I avoid LSIFs because, as investments, they offer few merits:
Collectibles By collectibles, I mean objects that people collect with the hope of selling later for a profit. Coins, stamps, art work, wine, depression glassware, signed photos of athletes, antique furniture, old toys, limited edition china plates, hockey cards, etc. are included on the list of items that fall into the category of collectibles, which is great. While some collectibles will appreciate in value, many do not. Furthermore, the collectibles market is extremely fickle. Demand for a certain collectible can change dramatically as categories of collectibles go in and out of fashion. I have personal experience in this regard. My son once collected action hero cards. One year these cards were the hot item all the kids bought; the next year, the card shop closed due to lack of business. In addition to the risk of losing your investment, there are other issues to consider with collectibles. They may require significant space and specialized storage requirements, e.g. antique furniture and vintage wine, and may need to be insured, e.g. fine art. Collectibles also present special challenges if the collector moves. For example, how does one pack a china figurine collection to avoid breakage? I view collectibles as a hobby to enjoy, not an investment. If your hobby happens to result in a profit, consider yourself lucky. If you enjoy collecting certain objects, do spend some money on your hobby, just don't consider it investing. Currency Hedging Products Currency hedging is a way to reduce investment risk due to fluctuations in the exchange rate of a currency. It involves buying derivatives, such as options and futures contracts, which are very complex investments for the average individual investor. I don't invest in currency hedged products as I believe that over the long haul currency fluctuations tend to even out. If you are worried about the impact of currency fluctuations, leave the protection of your investments against this variable to the currency hedging pros. Note, however, that even the professional currency traders get it wrong sometimes. Guaranteed Minimum Withdrawal Benefit Products Judging by the glut of new products on the market, baby boomers nearing retirement are gobbling up Guaranteed Minimum Withdrawal Benefit (GMWB) products, e.g.Manulife's IncomePlus GIF Select, Sun Wise Elite Plus, Desjardins' Helios, etc. These products are a form of variable annuity that guarantees monthly payments no matter the current return rate of the underlying investment. They are usually based on specialized versions of regular mutual funds. Investors pay the fees charged by the underlying mutual funds plus extra fees for the GMWB option. For example, at the beginning of each year, Manulife charges 0.25% to 0.75% (depending on the risk level of the underlying funds) of the value of the holdings for the GMWB option. GMWB products are complex, expensive and since they are annuities, the purchase is irrevocable. With a little research, investors or their financial advisors can set up a stable flow of retirement income with similar risk and at lower cost than buying a Guaranteed Minimum Withdrawal Benefit Product. That's the reason why I think most investors should avoid GMWB products. Options An option is a financial instrument that gives the owner the right, but not the obligation, to buy or sell a specific security or commodity at a stated price within a specified time period. You essentially gamble on the future price of the security or commodity. Options trading is available through full service and discount stock brokerage firms if you open an account that allows options trading. Few individual financial advisors in Canada have the special license required to sell options. Options are complicated and can be very risky. In some cases, you could lose more money than you originally invested. While there are options schemes which can be used as a form of insurance against losses, these schemes require a detailed understanding of options and come at a cost. I think that only experienced, sophisticated investors who have a high tolerance for risk should consider options trading. The average investor should avoid options because they are complicated and a kind of risky "insurance" which may not be needed and are not readily available from many financial advisors. Hedge Funds Hedge funds are funds that are exempt from many of the rules and regulations governing other mutual funds. Consequently, these funds can invest in almost anything and often use highly speculative investment strategies that are unavailable to mutual funds. Hedge funds tend to be secretive about how they invest and investors may have little idea of the contents of the fund. The returns on hedge funds are potentially high relative to traditional stock investments but the risk of losing your money is greater. Readers will likely remember the Portus Alternative Asset Management scandal. The founders misappropriated millions of dollars from the fund and it was forced into receivership by regulators in March 2005. Like so many investing products and services, hedge funds do not share in investor losses but they do take a large share of any profits. Hedge fund investors pay the usual high fund management fees and, in addition, a percentage of any profits (usually 20%). Hedge funds traditionally required a very high minimum investment ($250,000) and hence were the exclusive purview of wealthy individuals and institutions. They are now available to many retail investors at much lower minimum investments - $1,000 and sometimes even less. Some are structured as a fund of hedge funds and, as such, charge yet another layer of fees. I think retail investors should avoid hedge funds because of the high risk of losing money, lack of transparency in how they invest and what they buy, and the excessive fees charged to purchasers. In Summary You've probably detected a theme here: the investments on my avoid list are high risk and/or investors pay substantial fees to the company that develops and offers the product. I think that sticking to carefully chosen stocks, investment-grade fixed income products, selected mutual funds, exchange-traded funds, and real estate offers a better risk-reward proposition for retail investors. Gail Bebee, B.Sc., MEng., Author of "No Hype -TheStraight Goods on Investing Your Money", Toronto, ON No Hype - The Straight Goods on Investing Your Money, |
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