4 Types of Investments to Avoid

One thing that I believe in is the power of investing. Investors who stay the course can build real wealth over the long term.

But not all investments are created equal. Investing in low-cost index funds is a great way to diversify and gain exposure to the whole stock market. In my opinion investing in a good total stock market index fund is the easiest way to get started with investing.

But I get that it’s boring.

Every now and then, you’re going to have other opportunities come your way that seem more exciting. Unfortunately, most of them are really going to be dead ends.

Here are four kinds of investments that are best avoided.

Your Buddy’s Business

I have a friend at my day job who goes on walks with me. About once a month he’ll use our conversation to vent about losing a bunch of money in his friends’ business.

His friend Jeff started a bar in Mexico and he was an early investor. The bar failed and now Jeff wants more money to pivot to a restaurant.

It’s exciting to get the opportunity to invest in something early. The best case scenario is pretty darn good: You play a part in making something happen and get a good payoff. The problem is that the best case scenario is also highly unlikely.

More likely is that you’ll lose your money and learn a hard lesson.

The truth is that the life of an entrepreneur is marked by failure. Successful entrepreneurs aren’t always successful, they just get in enough attempts for something to work. And they only need one thing to work.

This means that the best way to invest in these kinds of businesses is to diversify. If you have enough money to fund lots of projects, it won’t matter that most of them fail.

This is how successful angel investors operate. They invest in a huge amount of businesses. Most fail. The ones that succeed (facebook, shopify, uber, etc.) more than make up for the ones that fail.

Of course, you might have spotted the problem. You don’t have the time, money, or opportunity to invest in a bunch of businesses. Unfortunately there’s no good way around this. This kind of investment is best suited for people who are already wealthy and well connected.

The Speculative Get Rich Quick Scheme

Everyone’s dream is to get in early on an investment that goes to the moon. You invest $10,000 and become a deca-millionaire. Articles get written about how smart people like you are. All your friends get very jealous.

It’s an attractive fantasy, but it’s a fantasy.

The reality is that by the time you hear about an investment, it’s probably too late. I know that you like to think that you’re well connected. That you’re ahead of the curve. But chances are you aren’t.

This approach suffers from the same weakness as the last one: Any individual investment is more likely to lose money than make money. You need some kind of diversification. But diversification is expensive.

And you have better investment options. They may be more boring, but they are safer.

No, my index fund won’t 1,000x over the next decade, but no one reliably knows how to pick an investment that will.

The MLM With a Pricey Buy-In

Multilevel marketing is the original viral hit.

Someone you know starts selling something directly and soon everyone you know is talking about it.

We all know that you have to watch out for MLM’s becoming pyramid schemes. You start buy selling to your friends. But the real money is when you convert them to distributors.And the real money is when they start signing distributors.

But pretty soon everyone is a distributor and there’s no one left to sell to.

This problem gets even worse with an expensive buy-in. I’ve seen MLM’s that want you to fork over $10,000 for inventory to get started. They justify this by saying it’s the startup cost of starting your own business.

I hate to break this to you, but you aren’t starting your own business when you join an MLM. You’re joining someone else’s.

Unfortunately, most people won’t recoup their initial investment. And they’ll sink a bunch of hours into trying.

What’s worse is that some people will sell half their inventory, realize that they’ll never sell the other half, and be faced with the decision of needing to buy even more inventory to keep selling.

Our MLM

Despite the way I’ve been talking, I’m not completely against MLM’s. My wife is actually a distributor for an MLM (Usborne children’s books). But the MLM she is a part of has certain features that make it a good option:

• There’s no startup cost or buying inventory, its straight commission from items in a catalog.
• My wife isn’t focused on making money by recruiting distributors, she makes money by making sales
• She realizes this isn’t a business she’ll scale to a career. It’s money on the side when she needs it

These factors have combined to give us a positive experience with an MLM. But there are plenty of horror stories out there. So be careful.

Individual Stocks

I had to get this shot in there.

It’s so tempting to think that you can beat the index. Just identify the stocks that are going to go up and avoid the obvious losers.

There are two critical problems to this way of thinking.

The first is that you have absolutely no idea which stocks will go up and which will go down. Sometimes you might guess correctly, but a broken clock is right twice a day.

Many of today’s successes are tomorrow’s overnight collapses. And many of today’s losers are tomorrows feel-good turnarounds. But some successes are just regular successes. And some loses are just losers. There’s no way to tell which is which.

The other critical issue is that when you try to beat the market, you’re engaging in a zero-sum battle with other investors. If you beat the market, you do it at someone else’s expense. Many of these investors have devoted their careers to picking individual stocks. Can you beat them at their own game?

Why I Don’t Invest in Single Stocks (But Maybe You Should)

What to Do When Tempted to Speculate

If you just can’t stand how boring index investing is, you’re welcome to venture out into something more speculative. But be smart about it.

Have the humility to realize that the money you devote to sexier investments is likely to under perform the boring investments over time.

The best way to protect yourself is to cap your exposure.

I like using the 90/10 rule for this. Under this rule, 90% of contributions go to the boring index fund, 10% to something more exciting.

And who knows, maybe that 10% really will go to the moon.

Use the 90/10 Rule When You’re Tempted to Make a Speculative Investment