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There are many investments which are complex and difficult to understand (even for experienced investors).Here we provide a brief overview of some of these high-risk products. We recommend you seek professionalfinancial advicebefore you invest in any of these products.
A CDO is asecuritythat consists of a bundle of individual loans and other debts that have been packaged up together. They include debts with mixed creditworthiness, such as mortgages, car loans, credit card debt and corporate debt or bonds.
They are called collateralised because they are backed by some type of asset (collateral). When you buy a CDO you take on the risk that the initial loans will not be repaid and receive interest payments in return.
CDOs range from reasonably secure to highly risky. These are the products that triggered the global financial crisis.
Foreign exchange trading is where you buy and sell foreign currencies to try to make a profit. See ourforex pagefor information about how to trade currencies and the risks involved.
Futures are contracts to buy or sell a particular asset (or cash equivalent), at a specific price, on a specific date in the future. For example, a company may use a futures contract to lock in the price of a foreign currency it needs to buy at some future date. Futures are also widely used forspeculativetrading. They can be bought and sold on theAustralian Securities Exchange (ASX).
A futures contract is legally binding, no matter what the market value of the asset is when the contract matures. This means either the buyer or the seller of a futures contract can potentially face high losses.
Try theASXs futures courseif you want to find out more.
Options are contracts between two parties that give the buyer the option to buy or sell a particular asset, at a set price, on or before a specified future date. The seller keeps the money paid for the option, even if the buyer doesnt exercise their rights. If you buy an option but dont exercise your right to buy or sell the asset by the due date, it expires and becomes worthless.
Selling an option can be very risky, especially if you dont already own the underlying asset. If the market price rises above the exercise price you may be forced to buy at the market price and immediately sell at the lower exercise price, incurring an immediate loss. Options can be bought and sold on the ASX.
Try theASXs options courseif you want to find out more.
Binary optionsare a type of option where you try to predict the short-term movements of a share price, currency, index or commodity. They are high-risk products. For more information, seebinary options.
Hedge fundsare investments that, likemanaged funds, use pooled funds to invest in alternative assets or strategies. These strategies tend to be more complex than traditional managed funds and may include the use ofderivativesandleveragein both domestic and international markets. Many hedge funds aim to profit in both rising and falling markets.
Hedge fund returns may have a low correlation with more traditional assets, such assharesandbonds, which can make them a good way to diversify a portfolio.
Hybrid securitiesare a way for banks and companies to borrow money from investors in return for interest payments. They are offered by banks and large companies and combine features of bothdebt(fixed interest) andequity(shares). Each investment has its own terms and conditions, timeframe and interest rates. They can usually be traded on a secondary market such as the ASX.
An infrastructure investment is an investment in a registered managed investment scheme or infrastructure company, that invests your money in projects like roads, railways, ports, airports, telecommunications facilities, electricity generation, gas or electricity transmission or distribution, water supply, sewerage or hospitals.
These investments are usually listed on a public market such as the ASX. Investors can also access a small number of unlisted companies and unlistedunit trustsby dealing directly with the entity. Unlisted entities are lessliquidthan some investments, which could limit your ability to withdraw your money when you need it.
See ASICs guide toInvesting in infrastructure.
Aninvestment bond, also known as an insurance bond or growth bond, is an investment offered by an insurance company or friendly society. It is technically alife insurancepolicy, that also has features similar to a managed fund.
Its a long-term investment, designed to be held for at least 10 years and can be very tax-effective, providing you follow the contribution and withdrawal rules.
Astapled securityis an investment with two parts that cant be separated from each other. For example, alisted property trustinvestment stapled to shares in the company that manages theproperty trust. The trust is the legal owner of the property assets. The related company manages the fund and development opportunities, for a fee.
Some complex investment products are extremely risky advises Paul Clitheroe.
Contracts for difference, collateralised debt obligations,futures and options are all potential minefields. People buy them because they think they can make a lot of money quickly. The reality is they could lose money quickly.
These products are incredibly complex to understand, even for an experienced investor like me. If you are considering buying these products, think of how much you can afford to lose, not just how much you hope to gain.
Paul Clitheroe is Chairman of Money Magazine and the Australian Government Financial Literacy Board
Some complex products attract investors looking to make a quick buck or those looking for higher than usual returns. This may seem tempting, but remember, higher returns carry higher risk, so read investment documents carefully and consider how they fit into your overall investment plan.