Why Certain Financial Products are Risky and How to Avoid Them
In my 30 years in this business, I’ve witnessed countless investment products rise and fall. Many of these offerings were created by major financial institutions with the intent to capitalize on investor demand or the latest market hype. And while they often promise innovation, excitement, or high returns, their risks can be deeply embedded and hard to understand. Unfortunately, these products do not always put the investor’s best interests first, and many contain pitfalls that can quietly erode wealth. Over the decades, I’ve seen how easily investors (myself included) can be drawn into strategies that appear sound on the surface but can be damaging in practice. Below, I highlighted nine of the worst investment mistakes I’ve encountered, along with historical lessons to help you avoid them.
1. Leveraged ETFs: Compounding Losses
Modern investment products often appear promising, but beneath the surface lie significant risks that can quietly undermine your portfolio. Leveraged ETFs, whether 2x, 3x, or their inverse forms, can look tempting because they magnify short-term returns, but the reality is harsh. Investing in both a 2x leveraged ETF and its 2x inverse counterpart does not guarantee offsetting gains and losses. In fact, compounding negative returns with leverage almost always leads to bigger losses. During the 2008 financial crisis, many investors experienced just how insurmountable these losses can be, as volatility and leverage together destroyed capital.
2. Using Inverse ETFs to Mitigate Risk
Attempting to mitigate risk by using inverse ETFs is another dangerous approach.
Suppose your portfolio is 75% in a broad index fund and 25% in cash. Rather than selling 25% of your index to reduce the exposure to 50%, you use your 25% in cash to purchase an inverse ETF. The outcome in either case is a 50% allocation to the market, but you forfeit the interest or yield that cash would have generated by using the inverse ETF. In downturns like the dot-com crash, investors who kept things simple by holding cash instead of using complex inverse products were generally better off. The lesson is clear: simplicity can help preserve capital, while complexity can expose you to risks you may not expect.
3. Chasing New Investment Products and Trends
New investment products, especially those chasing hot trends, are often more hype than substance. Emerging energy, infrastructure, or technology plays may sound exciting, but being early can be costly. The dot-com bubble in the late ‘90s is a classic example: investors hoping to strike gold ended up with heavy losses when early-stage markets failed to deliver. Ultimately, these innovations may meet early expectations, but the early investments can be too steep and the payoff too distant. Sometimes the better play is to wait for dust to settle, picking up undervalued assets for pennies once the hype passes.
4. Buying Into New Assets or Asset Classes Too Early
Wall Street’s innovation brings new assets and asset classes. Some are genuinely valuable, while others are opaque and can be destructive. Too often, the downside becomes clear only when it’s too late. In trying to assess risk, we typically look back to a stressed point in the market to see how the asset performed. With new financial products and asset classes, this information doesn’t exist and may be difficult (or near impossible) to accurately model. Remember how mortgage-backed securities fueled a major crash in 2008? Their complexity masked the risk, resulting in devastating consequences for many.
5. Investing Without Understanding Costs
Every investment comes with costs, including fees, taxes, and expenses, which can significantly impact your returns. Even strong investment ideas do not always translate into investable solutions for investors. In many cases, it’s not uncommon to see most of the gains going to the asset managers or product creators instead. Ignoring these costs can result in disappointing outcomes, especially when hidden or ongoing fees add up over time.
6. Commodity-Based Exchange-Traded Products Without Understanding Market Dynamics
Commodity-based exchange-traded products (ETPs) pose unique dangers. If you aren’t well versed in market mechanics like contango and backwardation, steer clear. The 2014 oil crash exposed many investors to losses they didn’t understand, as futures pricing structures steadily eroded the value of exchange-traded products.
7. Closed-End Funds: Buying at a Discount for the Wrong Reasons
Closed-end funds dangle the prospect of buying at a discount, but persistent discounts may be symptoms of deeper issues. High costs, poor management, or illiquid assets can all limit their value and increase risk. The 2008 financial crisis saw some closed-end funds suffer even more than the broader market, as leverage amplified losses, and widening discounts added further pressure. The lesson here: a discount alone does not make a fund a good opportunity.
8. Overusing Leverage in Investment Products
Leverage in investment products is a double-edged sword. It can magnify yield, but it can also magnify losses. This is especially true in bonds. Borrowing money to lend money sounds attractive, but history teaches us that downturns hit leveraged bond investors hardest, as seen in the severe setbacks of the 1994 bond market crash.
9. Chasing Yield Without Considering Risk and Taxes
Chasing yield is a common mistake. Higher income may look attractive, but it often signals higher risk. In bonds, unusually high yields can be a sign that repayment is less secure than it appears.
High-yielding stocks involve trade-offs too. Remember, companies have few choices of what to do with their free cash: pay dividends, buyback stock, or invest in the business. Both stock buybacks and investing in the business are indications from management that the stock has appreciation potential. Dividends are an indication that the investor is a better recipient of the money than the company. can use free cash to pay dividends, repurchase shares, or reinvest in the business.
Buybacks and reinvestment often reflect confidence in future growth, while dividends may limit that upside.
Always consider the trade-offs between yield, risk, and taxes.
A better approach is to focus on fundamentals. Keep your portfolio simple, stay disciplined, and understand exactly what you own. Be wary of complexity and innovation for innovation’s sake. In investing, often the most expensive mistakes come from reaching for more and ignoring the risks.
