I’ve talked a lot about what you should invest in here on my website. It’s pretty clear that low-cost index tracking ETF’s are the best investment for most people. You can read more about them here. I haven’t talked in depth about what you shouldn’t invest in. Today I’m going to chat about a couple of popular types of investment and explain why you should avoid them like the plague!
For some reason, this is incredibly popular. There’s a good chance you’ve heard of foreign exchange or forex trading. If your initial instinct was to be sceptical that you could make quick money trading foreign currencies, you’d be right.
Let’s do a quick breakdown of what foreign exchange trading is. Currency values fluctuate like anything else, and foreign exchange trading is the attempt to profit from that. Lots of different things can change currency values. A quick example: if NZ’s interest rates rise it would probably increase the value of the NZ$. In this scenario NZ term deposits and bonds will offer a higher rate of interest and more foreign investors will want these deposits and bonds.
A foreign exchange trader would attempt to guess when situations like the above would happen and buy/ sell accordingly. This is trying to “time the market” which as I’ve mentioned about a million times, just doesn’t work.
Why you probably won’t profit from it
Foreign exchange trading is what is known as a negative sum game.
This means is that the sum of what everyone ends up with is less than what they bought in. Unlike a stock, a currency won’t produce any value on its own. For one currency to go up, others have to fall, as opposed to a stock market where shares go up collectively over the long run. Every forex trade you make incurs fees, which quickly add up and make it very difficult to profit.
Looking at it another way, for you to win in a foreign exchange trade, someone has to lose. Foreign exchange trading is pretty much gambling (but instead of betting on a horse or a sports team, you’re betting on currency). It’s speculating, not investing.
I have no doubt that some people make money from foreign exchange, but they are very rare. For every one person that makes a killing on forex, there’s probably thousands who lost their money.
The best bet is to completely ignore forex trading.
This leads me to another new kind of “investing”…
Binary Options are a zero
You’ve probably seen (and impatiently skipped past) YouTube ads saying “How did GoPro make a billionaire?”.
They’re advertising what’s known as a binary option.
A binary option is essentially placing a bet (though they’d call it an investment) on what’s going to happen on a given stock in a particular time frame. For example, I might think Apple’s share price is going to rise today. I’d purchase a binary option on Apple and if the share price did go up, I’d make money. If not, I’d lose money.
This suffers from the same problem as forex trading – it’s a negative sum game. Because of fees, you have to be successful in more than 50% of your trades to break even.
I’ve talked heaps about how hard it is to predict what’s going to happen in the sharemarket over weeks or months so imagine how hard it is to predict what’s going to occur in the next hour or even 10 minutes!
Got any idea what’s going to happen with Google’s share price in the next 20 minutes? Me neither.
Don’t try to mix gambling and investing, and ignore forex and binary options.
What about Gold?
I’ve talked about gold briefly before. I used to own it until I got more savvy about investing.
Before modern currencies came along people used to trade real golden coins, and later bits of paper that gave you a right to pieces of gold. As modern economies have moved away from the gold standard, gold has become less relevant.
While a company stock has value because of the assumed future profits that company will produce, the only value gold has is the value people give it. Gold doesn’t do a heck of a lot; its value is that it’s shiny, durable and scarce.
Gold bugs (people who love investing in gold) believe that if world economies collapse people will go back to using gold to buy things. The only time gold goes up in value is if there is an economic downturn and people freak out. In times of recession, gold usually goes up in value as investors flock to seemingly safer investments.
It’s an emotional investment – people buy it when they’re afraid of what the future holds (e.g. Brexit). It’s nice to own something physical when it seems like the world is collapsing. This is exactly the investing you want to avoid. Gold gives you no income, whereas stocks pay out dividends. Not only does it not make you any money, but it’ll also cost you money if you want to own physical pieces of gold.
As the value of gold often moves in the opposite direction to stocks, it can be argued that it’s a good idea to make gold a small % of your portfolio. This is potentially true, but it’s not worth worrying about when you’re young and should be focusing more on maximising growth than on security and balance.
Don’t get sucked in
So now you know a few ways of investing to avoid. Forex trading and binary options appeal to people’s desire to get rich quick, while gold investing appeals to fear. Like I’ve been saying – ignore the noise. You know what’s the best option for you, and listening to hysteria or the prospect of get-rich-quick schemes is not going to help you or your finances in the long run.
If you want to learn more about how to invest successfully for the long run, check out my Investing for Non-Millionaires series.
- Part one: I outline the best way for regular people to invest
- Part two: I interview another finance blogger on how she invests