The beginning of a new year is usually a good time to reflect on the past in order to make certain resolutions about the coming one. In investing, future success can have little to do with what has worked well in the past. Trying to predict short-term market movements is also generally an investment strategy that can lead you to financial ruin. Keeping these perspectives in mind, below are five of the dumbest things you can do with your money in 2012.
Lately, it has been en vogue to consider volatility its own asset class. Trading volatility has become possible through vehicles based off the Chicago Board Options Exchange Market Volatility Index, or VIX for short. A range of exchange-traded funds (ETFs) have been created so that investors can make bets on the extent to which the market bounces up and down. There are even ETFs that let investors gain twice the exposure to market volatility, which can be used to make bets on both advances and declines in the market.
The problem, as with most short-term strategies, is developing a compelling trading strategy capable of predicting market volatility. Trading VIX-related indexes may make sense for hedging near-term market fluctuations, but there is simply not going to be any way to predict market moves with any certainty. Major inflection points in the market are missed by the best investors and include the credit crisis, flash crash and latest concerns over sovereign debt levels in Europe. Without a crystal ball, speculating on future market volatility has to be one of the dumbest things investors can do with their money. (To learn more on volatility, read A Simplified Approach To Calculating Volatility.)
Buy Bond Funds
U.S. interest rates have been on a steady decline since around 1980 when they reached the double digits. These days, shorter-term rates are hovering around zero, while the 30-Year Treasury Bond rate is extremely low at roughly 3%. These low rates qualify as all-time lows in many instances, such as for bank Certificate of Deposits (CDs), mortgages and U.S. Treasury rates.
Savvy investors, including Pimco’s Bill Gross, have lamented at the low interest rate environment. Sadly enough, Gross’s near-term call on the appeal of U.S. Treasuries has left his flagship Pimco Total Return Fund badly lagging its index and an estimated 84% of its peer group. Given the low historical rates, many see it as only a matter of time before rates start to rise. As bond prices move in the opposite direction of yields, there is the potential for sizable losses for many investors in bond funds. At the very least, investors should consider investing in individual bonds to at least ensure the return of their principal at maturity. (For related reading, see Bond Basics.)
Speculate in Currencies
As with trading volatility, speculating in short-term currency movements is another dubious investment strategy. As with most investing, a long-term perspective can be much more meaningful. The Economist magazine issues a Big Mac Index, the origin of which has been described as a “light-hearted way to make exchange-rate theory more digestible.” Namely, it looks at the price of a Big Mac across the world as a proxy for the extent that currencies are either undervalued or overvalued, relative to each other. Specifically, it states “that in the long run, the exchange rate between two countries should move towards the rate that equalizes the prices of an identical basket of goods and services in each country.”
Betting on short-term movements in currencies is a certifiably dumb strategy, as shorter-term fears and emotions can push currency relationships far off from what is reasonable over the long haul. The carry trade, or borrowing in a currency with a low interest rate to invest in one with a higher interest rate, is a case in point. A popular carry trade in recent years involved borrowing in the Japanese yen, and it has unravelled at various times, including during the credit crisis in 2007 and natural disasters earlier this year. As with many short-term market movements, many speculators were caught by surprise. (For more information, read The Big Mac Index: Food For Thought.)
Load Up on Gold
A market strategist at Fifth Third Bank recently suggested that investors in gold implement a gambling strategy that also works in Las Vegas. After a big win or run up in any investment, put your initial capital back in your pocket and continue to play with house money. This minimizes the potential that an investment, such as gold, which has had an amazing price run, stops for a breather or gives up most of its original gains. Investors in residential real estate back in 2005 and 2006 would have been well served with this strategy, and while gold may continue to have a strong run (gold is up more than 150% over the past five years, while the stock market is flat), buying it aggressively at these levels is likely a very foolish trading strategy.
Invest in Social Media
The fact that many social media firms continue to push through initial public offerings (IPOs) in the face of a difficult stock market should serve as a solid indicator that these companies have unknown underlying business appeal over the long haul. Firms including Groupon, LinkedIn, Facebook, Zynga and Twitter may be growing sales rapidly, but they are spending just as much to advertise and boost sales.
Collectively, they have unproven business models, barriers to entry are very low as competing sites are rather easy to develop, and hundreds of millions of dollars of investment capital are pursuing only a handful of good ideas in the space. It all spells a recipe for disaster, for investors looking to invest these days. (For related reading, see How An IPO Is Valued.)
The Bottom Line
Smarter investment choices include buying into blue-chip stocks and even residential real estate in many markets in the U.S. With a long-term perspective, many wise investment choices can be made. The dumber ones generally consist of trying to predict short-term market movements and piling into investments that have had very strong price runs or are extremely popular.
This story was originally published by Investopedia.