Risk isn’t just your favorite board game.
Investors have to deal with another type of risk on a day-to-day basis: investment risk.
U.S. Treasuries are often called “risk-free” investments. It’s the least risky investment there is, because people don’t believe that the U.S. government could default on bond payments.
For everything else then, there is some risk attached. We can think about the risk of an investment as the probability of losing all or some significant portion of the investment.
So why don’t people simply invest 100% in U.S. bonds and call it a day? Why take on any risk at all?
The answer is that the market rewards investors for taking on risk. Historically, the riskier an investment is, the higher its return will be. So government bonds have lower risk and return, than corporate bonds, which in turn return less than blue-chip stocks and so on.
So as a thought experiment, what if you wanted to put money in the most risky investments? What would that look like?
These are 5 risky investments from around the world:
1) Leveraged ETFs
A leveraged ETF is like the souped-up version of an ETF. It tries to amplify the returns of an underlying ETF by using financial derivatives and are typically used to speculate on short-term price movements.
Leveraged ETFs are described as being leveraged 2:1 or 3:1. At a 3:1 leverage ratio, an investor makes 3% when the underlying index of the ETF rises 1%.
As you can imagine these ETFs can go through some crazy swings. It’s not uncommon for a leveraged ETF to gain 200% in the space of three months, before completely losing all of those gains in the next three months
2) Junk Bonds
On the face of things a junk bond is the same as any other bond. Remember, a bond is like an IOU on borrowed money. One might borrow money from you, and tell you they will pay it back with interest.
A junk bond is an IOU from a business whose creditworthiness is less than ideal. In return for taking on the risk of lending money to people and/or businesses who may or may not be able to pay you back, you have to be rewarded with a higher return.
These bonds can be lucrative. In 2009, the year after the stock market crash junk bonds returned 54.2%. Stocks returned just over half that in the same time. More recently, the U.S. Merrill Lynch Triple C High Yield Bond has returned 30.37% this year already.
Be warned though, because the default rate on Triple-C rated bonds can be above 20%, while it is a mere tenth of a percent (0.1%) for investment-grade bonds.
If you want to invest in real estate then REITs might be a good option for you. It’s a way for investors to invest in the real estate market without having to own property.
REITs are well known for paying out huge dividends. For example, the ProShares S&P 500 Dividend Aristocrats ETF (NYSEARCA: NOBL) has a dividend yield of 1.87%. So if you invest $100,000 then you’d make $1870 every year.
Fundrise - Become a Real Estate Mogul
Contrast that with REITs such as:
New York Mortgage Trust (NASDAQ:NYMT):
Dividend Yield: 15.9%
Invest $100,000 and earn $15,900 every year.
PennyMac Mortgage Investment (NYSE:PMT):
Dividend Yield: 12.07%
Invest $100,000 and earn $12,070 every year
You start to see how REITs can be huge income-generators, and they have this characteristic because they are legally obligated to pay out 90% of their incomes to shareholders.
Now, 12-15% in dividend payments sounds great and it can be tempting but the problem is that these types of REITs tend to be unstable in the share price. So while your dividend keeps coming, the money you invested keeps dwindling via the declining share price. When the share price goes down, so does your dividend. Bummer.
4) Venture Capital
The future of the next Uber or Google could be in your hands. There are tons of startups looking for funding from VCs and these days it is possible for the retail investor to fund smaller startups, especially using online platforms.
There’s a lot of risk associated with this type of investing, due to the simple fact that most startups fail. So you could pump a bunch of cash into a startup, and there’s a good chance you will never see that money again.
On the other hand the returns could be insane if you pick right. As an example, Peter Thiel turned a $500,000 investment in Facebook into more than $1 billion!
5) Emerging Market Equities
If you want risky stocks to buy then look no further. Emerging markets typically have greater economic growth and potential for higher investment returns when compared to the relatively more sedate developed countries.
Emerging market (EM) equities, of course, more volatile than developed markets. For instance, following the great recession the MSCI Emerging Markets Index (NYSEARCA: EEM) fell 53%, but gained 79% the very next year.
There are also risks associated with investing in emerging markets due to the political climate or lack of information that investors have access to. If you don’t have accurate information then you’re kind of flying blind as an investor.