When it comes to investing, everyone has their own tolerance for risk. That tolerance can vary depending on your financial situation, your financial goals, your age, and many other factors.
Most people are comfortable investing in some stocks, understanding that the potential for positive returns is usually worth the risk over time. Others avoid the stock market altogether and instead keep their money in safe havens like bonds or basic savings accounts.
Some investments offer the potential for higher-than-average relative returns, but they also come with a heavy dose of risk. These high-risk investments aren’t for everyone, but they could help a person on the path to wealth if they have the stomach for it. Let’s examine the potential benefits and drawbacks of some higher-risk investments.
- Some investments offer the potential for higher-than-average relative returns, but they also come with a heavy dose of risk.
- It’s possible to see twice or even three times a typical return using leverage (i.e., borrowed funds), but there’s an equal risk on the downside.
- High-risk investments include options, high-yield bonds, forex trading, emerging markets, penny stocks, and niche ETFs.
An investor who is looking to make more money can use borrowed funds to increase the potential return on any investment. When traders and investors use borrowed funds, it's referred to as "margin" or "leverage." It’s possible to see twice or even three times a typical return using leverage, but there’s an equal risk on the downside. Remember: leverage can magnify both your gains as well as your losses.
There are many leveraged products out there, including exchange-traded funds with double or even triple leverage. For example, you can invest in a triple leveraged S&P 500 ETF that will offer three times the return of the index. Of course, this means you lose three times the money if the market goes down. Moreover, the returns of these leveraged ETFs are based on the daily returns of the index, so you can lose quite a bit of money in a single day.
Leveraged investments may serve a purpose for some investors, especially those operating on very short timeframes, but they are rarely good products for those with a focus on the long term.
When you buy an options contract, you are essentially buying the right to purchase or sell an asset at a set price before a certain date. For example, you may sell an option that essentially is a promise to sell 100 shares of Apple stock at $150 per share next Friday. If next Friday rolls around and Apple is trading for $130, the person you sold the option to won't want to take you up on the promise to sell shares at $150, and you get to keep the money you made from selling the option.
Trading options is a way to potentially make money off a stock or another security—even if the market isn’t going up.
Of course, options don't always work out perfectly, and some kinds of options can result in large or even unlimited losses, especially for the people selling options.
Options are especially high-risk when they're "naked." Naked options aren't covered by a long position in the underlying stock. That means, if you're wrong about the stock direction, you'll have to pay the difference between the stock price on the day the option expires and the strike price.
For instance, someone betting against a stock with a naked option can lose a lot of money if the stock goes up. Let’s say that you believe Apple’s stock will not rise above $150 per share. You enter into a contract with a “strike price” of $150 set to expire in December of 2021. If December rolls around and Apple is trading at $210, the investor loses the difference: $60 per share, or $600 per options contract. The potential loss for this kind of trade is theoretically unlimited because there is no cap on how high a stock price can go.
It can take time to understand the ins and outs of options, so only experienced traders should consider using them. Even those with experience can lose large sums of money through options.
It’s common for older investors and retirees to invest in the fixed income market through corporate bonds, municipal bonds, and U.S. Treasuries. Treasuries, in particular, rarely default, which make them a popular way for conservative investors to receive a steady, predictable stream of income.
Most bonds come with ratings based on the creditworthiness of the borrower, with AAA ratings for the most reliable bonds and ratings as low as CCC or even D for the weakest bonds. Bonds with low ratings are often called “non-investment grade,” “speculative” or “junk” bonds.
It’s possible to make good returns off low-rated bonds, as a low rating is not a guarantee that the borrower will default. However, it’s rarely a good idea to put a large percentage of your money in these types of bonds, because they do occasionally default.
The values of currencies can change quickly and dramatically. Your ability to predict and act on these movements will determine your success in making money on the foreign exchange market, or forex. The wild swings of currencies, especially outside the U.S., offer the potential for high returns if you forecast the changes correctly.
Trading on the forex is not for the faint of heart, as a wrong bet on a currency can result in the loss of everything you have invested. To make matters riskier, currencies are often traded using leverage, so your losses can be multiplied.
When trading currencies, it’s best to avoid having too much money tied up in one trade, only trade with cash (don't use leverage), and use stop-loss orders to prevent major losses.
Emerging and Frontier Markets
The U.S. stock market has reliably risen in value over time, so finding true bargains is not always easy. That’s why many investors look abroad to fledgling economies for growth opportunities.
It’s possible to invest in equities and debt from emerging economies such as China, India, and many countries in South America, Africa, and Eastern Europe. These countries are earlier in their growth cycles compared to the United States, so there's potential to see investments rise in value over time.
Frontier markets are usually smaller and even further behind emerging markets in terms of growth but still may offer opportunities for investors. Countries such as Estonia, Vietnam, and Kenya are often considered frontier markets.
Emerging and frontier markets offer enhanced growth opportunities with extra risk. These countries are often not as stable economically or politically. A lack of stability makes them more likely to default on debts than stable countries like the U.S. Their markets can be far more volatile and unpredictable. It’s not a bad idea to mix emerging and frontier investments into your portfolio, but as with every item on this list, diversification is crucial. Make sure you balance them out with safer and more reliable assets.
Most investors are accustomed to seeing publicly traded stocks on major exchanges like the New York Stock Exchange and Nasdaq. But many companies are too small to be listed on these exchanges, and therefore trade “over the counter” or on the so-called “pink sheets.” You can buy shares of these companies on the cheap, and if they later grow explosively, you can make a lot of money.
Keep in mind, however, that these stocks are trading over the counter because they were either de-listed from major exchanges or were never large enough to be listed in the first place. A large number of these penny stocks never rise in value. In fact, many of these tiny companies barely report any sales or income at all—they exist only on paper.
Moreover, penny stocks are often the subject of price manipulation. Dishonest people may promote a company's shares to "pump" up the stock price and then "dump" the shares suddenly at a profit. Those who bought the stock as it was pumping will be stuck holding shares at a loss after the dump.
The number of exchange-traded funds has grown dramatically in recent years. As of 2020, there were more than 7,600 ETFs available to investors, and many of them have very specific and unique investment goals. There are ETFs tied to just about any market and index imaginable, with many designed to offer potentially high rewards in exchange for high risk.
There are several ETFs, for example, that attempt to mirror the VIX, or volatility index. There are also inverse ETFs designed to go up when the market goes down (and vice versa). These types of investments could offer the potential for higher returns than more mainstream investments, but they can also expose an investor to potentially higher losses. The general advice to average investors is to stay away from these types of niche products.