Investing is a game of risk. No matter what the economy looks like and what you invest in, it’ll always involve some uncertainty. Taking that leap can lead to big payoffs in some cases, but some investments are too risky to be worth your time.
There’s a lot of financial noise out there, including many promises that can seem too good to be true. To help you separate that noise from real opportunities, here are five investment types to avoid and five alternatives to try instead.
Investments to Avoid and Alternatives That Are Worth It
1. Penny Stocks
A penny stock costs $5 or less per share, though some people consider them to be those below $3 or even $1. These shares of tiny companies seem promising at first because they’re so cheap. If it’ll cost you just a couple of bucks to invest, what’s the risk?
The problems come when you stop and consider why these shares are so affordable. The companies behind them are often rapidly losing cash and trying to sell out the business before it’s too late.
Penny stocks are a favorite of “pump-and-dump” schemes, where people hype up an investment to drive its price before dumping all their shares at a profit. Other shareholders will convince you are investing in the next Amazon, then abandon their stocks as the price crashes. These schemes and fraud cases are so common with these investments that the Securities and Exchange Commission has issued warnings about them.
Alternative: Savings Accounts
Consider a savings account if you like how little you need to invest in a penny stock but don’t want the risk. Opening a bank account is a far less glamorous option, but it’s similarly affordable and carries much lower risk.
Savings accounts face more regulation than penny stocks, such as FDIC insurance, so fraud is less of a concern. They’re also fairly resistant to macroeconomic changes, and while some accounts have minimum sizes, you don’t need to put much in them. You’ll make money from interest rates, which are often low, but holding these accounts for a long time can produce some comfortable savings.
Returns on savings accounts are too low to be your only investment option, but they’re a good way to expand your portfolio. If nothing else, they’re an easy, safe way to create some cash to fall back on in hard times.
Timeshares are another investment that can seem too good to be true initially, and that’s often the case. In these setups, you’ll purchase a partial ownership of a property like a vacation home in return for a set time, usually one week annually, when you can stay there. It sounds like an affordable way to get the vacation property of your dreams, but it’s typically not worth it.
When you factor in how much you pay for how little you get to use the property, you’ll quickly find that getting complete ownership at market price is a better deal. Because you only effectively own it for a week, renting it out while you’re not there is tricky, too.
Despite what a presenter might tell you, timeshares depreciate faster than a new car, so owning one has little long-term value. You may also find yourself locked in a contract with maintenance and upkeep fees the presentation didn’t tell you about.
Alternative: Rental Housing
Investing in rental housing is a safer and more practical way to get into real estate. If you want the closest thing to what a timeshare promises, you could finance a house and rent it out as an Airbnb or similar setup when you’re not using it. Alternatively, you could invest in an apartment complex.
Rental housing gives you ongoing payments in the form of rent that would be difficult to match with a timeshare you co-own with several other people. These rents could also help pay the property off sooner and without high upfront costs.
3. High-Yield Bonds
High-yield bonds can seem tempting at first, mostly because of their name. “High yield” certainly sounds promising, but their older term, “junk bonds,” may be more accurate.
The high yield in these investments comes from their high interest rates. They pay more than some other bonds, but that’s because they’re inherently riskier. These bonds typically come from companies with poor credit ratings, suggesting they’re less likely to pay off debts on time.
Not every high-yield bond represents a company doomed to go under, but it can be difficult to judge that from an outside perspective. Given how much a bankruptcy would impact you as an investor, it’s best to steer clear of these bonds.
Alternative: Real Estate Investment Trusts
One of the best alternatives to high-yield bonds is a real estate investment trust (REIT). A REIT is a business that owns income-producing real estate, often specializing in one type, like office buildings or apartment complexes. When you invest in these companies, you earn a considerable share of the profits from those properties.
REITs must pay at least 90% of their taxable income to shareholders. You could see some impressive returns in the right scenario, which might be what attracted you to high-yield bonds. However, unlike those bonds, REITs offer more security as they’re liquid.
Some REITs have a low barrier to entry, making them easy to invest in. They also provide a way to capitalize on real estate without having to manage it yourself, which can be helpful for beginner investors.
Another investment type you’ve probably seen a lot about lately is cryptocurrency. While relatively new, crypto has exploded in popularity over the past few years, generating a lot of investor interest, especially if you’re looking for something unusual to diversify your portfolio. However, as you might’ve noticed from recent news, crypto is extremely volatile.
Currencies like Bitcoin have seen massive growth at times, but their crashes are equally enormous. Crypto is also prone to hacking and scams, thanks to its relative newness and digital nature. Regulations around cryptocurrency are also continually shifting, making it hard to understand where it falls legally.
A much smaller supply than other investment types means changes in demand impact crypto much more than other opportunities. At times, that means skyrocketing growth, but you could see plummeting values at others.
Alternative: Crypto or Blockchain ETFs
Despite its issues, crypto and its underlying technology, blockchain, could see rising adoption in the future. If you want to capitalize on that potential but don’t want the risks of actually owning cryptocurrency, you could invest in a related exchange-traded fund (ETF).
Crypto and blockchain ETFs work like conventional ones: You invest in a group of companies that own these assets instead of the assets themselves. As a result, when crypto performs well, so will your investments, but you’ll have more diversification to lessen the impact of poor performance.
Some crypto ETFs follow the general market performance of major cryptocurrencies, while others focus on a more specific group. Blockchain ETFs follow companies producing blockchain technologies, which may not see dramatic growth as some cryptos but are less volatile.
5. Consumer Discretionary Companies
One investment class that may not stand out as risky is consumer discretionary stocks. These are shares in businesses that offer nonessential goods and services, like automakers, entertainment companies and restaurants. These aren’t as inherently risky as some others on this list, but they are prone to big swings in response to the larger economy.
These stocks boom when the economy is strong, but as it contracts and consumers spend less, their value can tank. Think about how airlines lost $168 billion in 2020 as the COVID-19 pandemic grew.
It’s worth noting that careful investment in some consumer discretionary companies can yield significant benefits. However, because these investments rely so heavily on the overall economy, they’re not the safest assets, especially for new investors. The future is uncertain, so you may want to temper your expectations about these stocks.
Alternative: Consumer Staples
Try staples if you want to invest in consumer goods and services but want more security. These assets fall on the opposite side of the spectrum from consumer discretionary companies. They’re businesses that people will always buy from, like food and beverage retailers, medical supply companies and personal care products.
Admittedly, these investments won’t reach the same highs as consumer discretionary companies during an economic boom. However, they won’t showcase the same dip during financial uncertainty.
Consumer spending accounts for 70% of the U.S. economy, so investing in the sector is a good idea. Going for staples over discretionary companies gives you a safer way to do so.
Investing can be intimidating, especially when so many initially promising assets can quickly turn sour. However, if you know what to look for and what to be cautious about, you can make smarter, safer decisions about where your money goes.
Every specific asset is different, but these five investment types are often too risky for most investors. If you want to make the most of your money, try the alternatives listed here instead. You can then get similar benefits with less risk.