By opening yourself up to elevated risk with these alternatives to building a sound stock portfolio, you set yourself up to become one of the “vulnerable investors” out there

In the past decade or two, we’ve often said that low interest rates can buoy the economy, but they can also spur investors to make choices they later regret. The most vulnerable investors are those who never really got comfortable with the volatility and uncertainty of stocks, or who had bad experiences in the stock market and never figured out what went wrong.

As they near retirement, these investors prefer to invest mainly in bonds. They are willing to take a chance on bond-alternatives, so long as they seem to offer safe, high yields of 6% to 10%, like those that were last available from bonds in the 1990s.

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Investing for the promise of high yields usually leads to vulnerable investors and portfolios

It’s easy to find promises of high yields today. Safety is harder to nail down. All too often, instead of using a healthy sense of skepticism to choose among investments now available, these investors let wishful thinking creep into their decisions. Unfortunately, as business coach Dan Sullivan warns, “Your eyes only see what your brain is looking for.”

I suspect we’ll soon start hearing reports of far more devastating results for vulnerable investors, due to so-called “alternative investments.” Many, many companies have gone into business in recent years to focus on this area.

Lots of these propositions involve futures and/or options trading systems. The sales pitch will tell you that “this is your chance to earn high, safe income.” It may go on to say that opportunities like this were formerly open only to the proverbial “rich and famous.”

The fine print will clarify that the promoter endeavours to provide high, safe income. In other words, they will try to reach that goal, but can’t promise success.

Participants in futures and/or options trading systems do at times make high profits, of course. That’s because futures and options give you access to high leverage, which lead to extreme outcomes. The outcome of any one trade is subject to a high random influence. However, random events tend to occur in bunches, so you’ll experience both winning and losing streaks. Of course, you’ll pay high fees and expenses in both, regardless of results.

One advantage of trading-system programs is that they at least deliver any bad news in a timely fashion, usually in monthly or quarterly statements, so you know what remains of your money while losses are still at an early stage.

Other alternative investments involve private contracts and long-term commitments. They also tend to be far longer, and to use novel language that leaves a lot of doubt about the exact meaning.

Few prospects go to the expense of getting an independent legal opinion. You can bet, however, that the promoters have invested heavily in expensive, highly qualified legal advice to limit their liability to legal action from unhappy investors.

Alternative investments are usually illiquid, or offer liquidity only at the promoter’s option. When cashing-in early is allowed, it may involve extra fees plus a lengthy wait. Promoters of these investments often try to portray this lack of liquidity as a plus.

However, the lack of a liquid market and the reporting obligations that go with it mean analysts and the media won’t look into or report on the alternative investment. This lack of outside attention increases the risk. It lets small issues grow into big ones before investors hear about them. You may only learn about problems when it’s too late to do anything about it.

Another disingenuous claim is that these investments offer growth without volatility. Volatility is a measure of price changes that take place during trading activity. These investments don’t trade, so their volatility by definition is nil. However, their underlying value is still subject to change.

That’s not a guarantee of growth. All it guarantees is that you may have a dreadful surprise when you try to cash in your investment.

Gambling on the future rather than investing in it creates vulnerable investors

Trading in futures is not the same as investing in stocks or funds. There are three fundamental differences investors must be aware of to understand the nature of futures trading:

• Futures contracts have a fixed life, usually under one year. You can hold stocks or mutual or exchange-traded funds indefinitely.
• Futures contracts do not give you any income. Stocks, and some funds, do provide dividend payments.
• Futures are a speculation—a bet on price movements. To make money, you have to outguess other players by a wide enough margin to pay commissions. Stocks and funds are an investment because they let you profit from economic growth.

Our investment advice: In theory, high leverage makes it possible to turn a modest stake into a fortune in futures. In practice, most futures speculators wind up losing money. Successful investors recognize that investing in futures is a form of recreation. You may do it for fun, but don’t count on it for profit.

Use our Successful Investor approach to make better choices for all of your investments

1. Hold mostly high-quality, dividend-paying stocks.
2. Spread your money out across most if not all of the five main economic sectors: Manufacturing & Industry, Resources & Commodities, Consumer, Finance and Utilities.
3. Downplay or stay out of stocks in the broker/media limelight.

Do you think futures investing involves fraudulent behaviour?

Do you feel like alternative investments target vulnerable investors or do you think it’s a mostly legitimate form of investing?