7 Investments That Might Be Too Toxic To Count On
So-called “toxic investments” gained notoriety during the 2008 financial crisis because they seemed to be everywhere. Even previously well-regarded blue chip stocks such as AIG were inundated with investments that were essentially worthless, requiring the federal government to step in and buy them before they dragged down these companies along with the entire U.S. economy.
Now, while the stock market endures volatility caused by global events, toxic investments are once again a burning topic of conversation. These days the term “toxic investment” can be more liberally applied to investments that the average investor should simply avoid. To make the most of your money, be aware of the investment mistakes you could be making.
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1. Subprime Mortgages
Subprime mortgages are mortgages taken out by the least credit-worthy customers, meaning they have very low credit scores. Statistically speaking, borrowers with lower credit scores are more likely to default on their loans. These mortgages do pay higher interest rates to investors, but they involve significant additional risk.
Why Subprime Mortgages Are Toxic
Subprime mortgages are the poster child for toxic investments. In the 2008 financial crisis, these were the investments — many of which ended up worthless — that dragged down some of the biggest names in the stock market, including Lehman Brothers.
Although lending regulations have tightened since 2008, subprime mortgages are still literally “subprime,” meaning they are low-rated investments with a higher potential for default. With so many other investment options available, the checkered history and low standing of subprime loans make them toxic investments.
2. Annuities
There are two main types of annuities: fixed and variable. With a fixed annuity, you pay a premium to an insurance company in exchange for guaranteed income payments, either for a certain period of time or for your entire life. With a variable annuity, your money is invested in mutual fund-like buckets that provide a variable rate of return that might ultimately be more or less than with a fixed annuity.
Why Annuities Are Toxic
Annuities serve a useful purpose for certain select investors. But for the most part, you can use other investments to accomplish everything an annuity can without dealing with the more toxic aspects, such as high fees and high surrender charges that can cost 7% or more if you withdraw money in the first few years after purchase. Annuities also have the same restrictions as IRA accounts in that you can’t withdraw money before age 59 1/2 without facing tax penalties.
3. Penny Stocks
According to the SEC, penny stocks are usually issued by very small companies that trade for less than $5 per share. In common Wall Street parlance, however, a penny stock is one that trades for less than $1 per share. Penny stocks capture the imaginations of many investors because they are cheap and the smallest move can translate into a huge percentage gain. For example, if you buy a penny stock at 50 cents and it climbs just 10 cents per share, that’s a 20% gain.
Why Penny Stocks Are Toxic
There’s a reason penny stocks trade at such low prices, and it’s usually because the company behind them is losing money and might be on its way to bankruptcy. Penny stocks are always a gamble because there’s so much manipulation in the market. Stock promoters publish articles about how XYZ penny stock is “the next Microsoft” or “the next Apple,” trying to pump the share price up so they can sell out at a profit. At best, penny stocks are a speculation, but they’re also subject to market manipulation, making them toxic investments.
4. High-Yield Bonds
“High-yield” is the relatively modern term for what used to be primarily known as “junk” bonds. Junk bonds receive low ratings from credit agencies regarding their ability to pay off their debts. Since they are by definition riskier investments, they typically pay higher interest rates, thus the term “high-yield.” Particularly in a low interest-rate environment, these higher-than-average yields can entice investors to take on added risk in an attempt to earn a higher return.
Why High-Yield Bonds Are Toxic
Companies with low credit ratings are just like people with low credit ratings — they’re more likely to default or go bankrupt. If you own a high-yield bond of a company that goes bankrupt, you’ll likely lose your entire investment. It’s hard for individual investors to get all the detailed information necessary to understand what’s really going on at a company, so choosing a high-yield bond that will survive is a challenge. Buying high-yield bonds via a mutual fund is a way to lessen this risk, but it doesn’t entirely eliminate it.
5. Traditional Savings Accounts at Major Banks
Savings accounts are secure, FDIC-insured investments that don’t fluctuate in value and provide investors with regular interest payments. They can be found in nearly any bank in the country, from long-standing, traditional banks to upstart online banks. So how can they be considered toxic?
Why Traditional Savings Accounts Are Toxic
Obviously, savings accounts are not “toxic” in the sense that they will lose all your money. However, “toxic” can be a very relative term. For starters, many of the most well-known banks in the world pay just a token interest rate. Chase and Wells Fargo are a couple of examples, with both paying investors a minuscule 0.01% on their basic savings plans. Even the national average savings rate is only 0.05%.
When you factor in inflation and taxes, your savings account money isn’t doing anything for you but sitting there. Keeping your money in this kind of savings account won’t ever generate the kinds of returns you should be shooting for in a long-term investment account or even what you could get with a high-interest savings account.
6. The Lottery
Lotteries are booming in the U.S., with most states now offering at least some form of the game. Since every multimillionaire created by the lottery is splashed all over the national news, it’s easy to get caught up in lottery fever, where a simple $1 or $2 ticket could change your life forever.
Why the Lottery Is Toxic
Want to know how hard it is to hit it big in the lottery? The odds of winning the Powerball jackpot are in the neighborhood of 1 in 292 million. This means you’re more likely to find a pearl in an oyster shell, get struck by lightning or date a supermodel than win the Powerball. It’s even more likely that an asteroid hits the Earth. There’s nothing wrong with occasionally playing the lottery for fun, but as an investment strategy, it’s toxic. To hammer this point home, consider that you’re also 1 million times more likely to catch the coronavirus than you are to win the lottery.
7. ‘Fallen Angels’
A “fallen angel” is a stock or bond that has fallen from its lofty perch back down to Earth. In the bond world, it usually means a company that has had a formerly high credit rating reduced to junk status. For stocks, it can refer to any high-flying stock that is now in the dumps. These investments are often tempting for investors because it’s human nature to remember former highs and think the current lows will eventually pass.
Why ‘Fallen Angels’ Are Toxic
Stocks that are falling sharply are also known as “falling knives” because, just like with a knife falling through the air, the odds that you catch it without getting hurt are minuscule. Many stocks that drop by 50%, for example, continue straight down until they have lost 70%, 80% or even 100% of their value. Since it’s nearly impossible to catch a stock at its absolute low, it’s a much safer course of action to wait to invest until a stock is back in a confirmed uptrend; only then does a stock have the potential to transform from a toxic investment to one with long-term growth potential.
This article was provided by MoneyLion.com for informational purposes only and should not be construed as financial, legal or tax advice.
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