One of the advantages of living in the world’s best free-market economy is the incredible number of choices we have.
It is astounding how many types of places there are to eat in New York City. Rome has the best Italian food in the world, but that’s all you can get there. In America, you can get nearly the best the entire world has to offer, and people keep coming up with new things all the time.
The stock market is no different. The traders of the Roaring ’20s would drop dead to see how many ways they can lose their shirt today. Futures, options, currencies, derivatives, swaps-none of these instruments existed back then.
I love all the innovations. Some time ago, the federal government established tax-deferred accounts for investors called individual retirement accounts. There are limitations on these IRAs. One of them is investors can’t sell short.
American innovation to the rescue. IRA owners can buy any registered mutual fund. About 10 years ago, someone registered a mutual fund that only shorts stocks. IRA investors can now go short through this mutual fund. Problem solved. Choices.
As our children grow up, we give them greater freedom. Problems arise because they don’t always want to accept the higher levels of responsibility that go along with freedom. Having more choice can sometimes be dangerous. The stock market today is full of products that, if handled improperly, can be dangerous to the user. One of these products is margin, and the increasingly complex ways investors can use leverage.
The Rydex mutual fund company offers funds that “seek 200 percent of the daily performance of” a particular index. If you buy the Rydex Velocity 100 Fund, you are leveraged 200 percent to the performance of the Nasdaq 100 Index. If the index goes up 1 percent today, you will make 2 percent.
On anything more than a day-to-day basis, however, there is compounding involved that can surprise investors. If you hold a fund like this for six months and the index is up 10 percent in that period, you may be up only 16 percent. And the downside can be even worse.
I have talked to several people who at one time or another “played” the options market.
The stories are usually the same. They started with a small amount of money and did OK for a while. Then they increased their stake and either lost it all or they grew frustrated and quit. I only know one person who hit it big. Options are sharp tools, and in the wrong hands they can cut.
I saw an ad for a trading system that claimed to have better than a 90-percent success rate on the stocks it picked. I discovered the company treated a lot of stocks that moved up 0.01 percent as winners, and it seemed to hold the stocks as long as it took for them to become winners. The system is probably not going to drastically hurt anyone, but you aren’t going to make anything, either.
There is an investment product and style for just about anything you can dream up. The trick is to know what you are getting into, and if you find something that really works, stick with it. You can make a lot of money with a little bit of focus.
Hauke is a local money manager. His column appears weekly.Views expressed here are the writer’s. Hauke can be reached at 566-2162 or at email@example.com.