Whether you're talking about cars, fashion, or investments, everyone always seems to want the hot new thing. But before you jump for whatever your broker wants you to buy next, take a step back and consider two things: whether you understand what you're getting into and whether you really need what it offers. Often, you'll find that the latest innovation won't give you anything new that you can't already get from much simpler -- and less expensive -- investments.
The next big thing
When the bull market in stocks was going strong, most investors were content to ride the wave upward and enjoy watching their brokerage statements give them the good news every quarter. After all, when a rising tide lifts all ships, you don't have nearly as much incentive to change what you're doing.
But after the financial crisis of 2008 and early 2009 hammered stocks, leaving investors facing a "lost decade" of stock returns following the bursting of the tech bubble in 2000, many people looked for alternatives to shelter them from the wrath of a bear market. More investors started noticing the big rise in gold and other commodities during those years and searched for access via managed futures accounts and structured products. Others sought refuge in hedge funds, private equity, and similarly exclusive investment vehicles that have traditionally been open only to wealthy investors. Specialized real estate plays also became more commonplace.
I'm not going to tell you that all of these ideas are terrible. Some investors have gotten rich from making investments like these. What you do need to understand before you make these investments, though, are the traps that many people don't have any idea about when they go beyond more tried-and-true investments.
Watch out!
The biggest problem with these investments is the major disconnect between knowledge and use. A recent MarketWatch article highlighted this problem, noting that a survey from trade publication InvestmentNews showed that more than half of financial advisors don't have the knowledge level about alternative investments that they'd like to have. By contrast, however, nearly 90% of advisors surveyed are comfortable using alternative investments in client portfolios and discussing their use openly with clients, and well over half expect to use alternatives more in the near future.
If financial professionals whose livelihood depends on making recommendations to less sophisticated investors find it difficult to get a full understanding of alternative investments, it's no surprise that those who manage their own portfolios may well have even more trouble. And more often than not, it's that lack of knowledge that causes the biggest problems.
Exchange-traded funds provide a couple of good examples. The United States Natural Gas ETF (NYSE: UNG), for instance, has lost a much larger chunk of its value than the long-term drop in natural gas prices would suggest was appropriate. Because of the ETF's futures-based strategy, however, the ETF's losses were predictable given prevailing conditions in the futures markets.
Similarly, leveraged ETFs such as ProShares UltraShort Silver (NYSE: ZSL) and Direxion Daily Financial Bull 3X (NYSE: FAS) owe part of their long-term losses to the underlying investments they track moving in the wrong directions. But investors are often surprised to see that once you go beyond daily holding periods, pairs of leveraged ETFs representing bullish and bearish bets on the same index often don't mirror each other -- and sometimes, both ETFs in a single pair will end up losing money in the long run.
Stick with what you know
What's more, compared to many alternative investments, ETFs are actually quite transparent and accessible. Unlike ETFs, many hedge funds and private equity investments don't let you get your money out for years after making your initial investment. Some even reserve the right to force you to add new money -- even if it has produced substantial losses. And the fees on some alternatives can make even the most expensive mutual funds look cheap by comparison.
Call it old-fashioned, but I still think that stocks give you just as good exposure to many markets as any alternative. If you think gold, silver, or other metals are going to keep rising, then companies like Freeport-McMoRan (NYSE: FCX) and Silver Wheaton (NYSE: SLW) will let you share in the resulting profits. Similarly, if natural gas soars, then up-and-coming industry players like Cheniere Energy (AMEX: LNG) or low-cost leader Ultra Petroleum (NYSE: UPL) should move up with it.
Don't let hot new investment types lure you into moving your money into things you don't understand. Even through tough times, stocks combine clarity and liquidity to give you the chance to earn profits from whatever businesses you think are most likely to succeed. In the end, that's the only investment you really need to make.
With all the attention that alternative investors put on energy, the right stocks can mean huge profits for shareholders. Don't wait to read the Fool's free special report with three great names that can ride higher energy to big gains.
