There are many different ways to invest money. They range from super easy and safe (a savings account), to more complex and risky (stocks and bonds). But there are some investments that should be avoided in all situations. Avoiding these kinds of investments will make it more likely you will buy something that will make some money.
1. Investments Based on Trust
A friend just told you that his friend has a great investment opportunity. Estimated returns will be 10% annually. There is only one catch – he hasn’t set up the business yet and so can’t sign any documents. This investment will be based on trust. This kind of investment opportunity should be setting off alarm bells for everyone. While in most cases this investment will probably be ok, the risk of failure is too high to take the risk. If there is a problem, there is no recourse for the investor. They will simply have to swallow the losses – an unacceptable risk.
2. Opaque Investments
If you invest in something, it would make sense that you understand what you are buying. This is called a due-diligence. Due diligence is easy for listed companies, such as stocks and corporate bonds. Due diligence isn’t really needed for treasury bonds or savings accounts. But it is very much needed for investments in real estate, or other illiquid products, such as private equity. For example, if you are buying a house, you would want to make sure there are no hidden maintenance nightmares awaiting you. A builder can come in to look at the property prior to purchasing to give the buyer peace of mind. This is the logic that should underpin all investments, and if due diligence is impossible, the investment should be avoided.
3. Investing Money You Can’t Afford to Lose
If you can’t afford to invest in something, don’t. Even if it’s a sure-fire winner, and everyone is telling you to buy it, just don’t. How many people mortgaged their house to buy Bitcoin when it was $20000? More than a few. Not only did they make a huge loss on their initial investment – but they are also now in debt. You should only invest money in risky assets that you can afford to lose.
4. Putting All Your Eggs in One Basket
One of the central concepts of finance is that asset diversification reduces risk. The more assets someone holds that are not related to each other, the less risk there is. This is because if you have 10 assets, one of those assets failing will only have a small impact on the overall portfolio. Conversely, if someone holds a single asset and it fails, they have lost everything. Diversification is key. You should never put all your eggs in a basket and focus on a single investment. Even if the one investment seems less risky, it will still be much riskier than a portfolio of 10 risky investments.
5. Something you don’t understand
You should always understand what you are buying. If you easily explain to someone what you are buying then just don’t invest in it. This holds true for equities (where the company is from an industry that you are unfamiliar with), or for more complex investment products that are simply very complicated (some kinds of insurance fall into this bucket). If you don’t know what you are buying – avoid at all costs.