Help a Reader: New Investor Asking About Futures, Options and Gold

Here's a question that I thought my well-informed readers could help answer. It was left as a comment on one of my posts:

I’m fairly new to investing and recently came into some money. A friend of mine told me to buy mutual funds through Vanguard and I allocated about a third of my money to several different funds. I chose the Capital Value Fund, Mid Cap Growth Fund, and the Energy Fund investor. I then put another third into a bond fund and am thinking about maybe putting 10% into futures and options and 10% into physical gold. I don’t know if my last two choices are smart and I’m not quite sure where to go for either. Any help would be appreciated. Thanks.

So, what would you advise him to do?

Comments

[Dave H.]

I think the Vanguard funds you bought are a good start. Personally, I'd probably have gone with the index funds, but you did choose funds with low expenses so I won't quibble. Regarding the futures, options and gold, I'd say forget it. I think what your portfolio is lacking (for balance) is an international component. How about an international stock index fund, and an emerging market stock index fund? Also, I would park some of it at 5.05% in Emigrant direct at zero risk. Regarding bonds, I wouldn't bother at the moment, since bond yields aren't much better than Emigrant's yield, and bonds have significant risk if interest rates rise. Finally, in entering new investments, you may want to "dollar cost average" on the way in (investing part of it each month), to insure against investing it all right at a market top. There's my 2 cents! Cheers, and good luck!

[Mama Money]

If you're fairly young, all things considered, I would take that money of the bonds and put it in a stock market index fund.

[EasyE]

It all depends on your world view. If you think that energy is going to be hot then invest in it. If you think that inflation will be a problem then invest in gold. Don't invest in anything that you don't understand and you will be ok.

[broknowrchlatr]

If you are fairly young, I'd forget the Bonds. Futures and Options are risky if you don't know what you are doing. For a safe bet, I'd put that money in either an index fund or a retirement target date fund (lifecycle fund).

I like T. Rowe Price 2040 (TRRDX) for good returns and lower expenses. I have over 50% of my portfolio in that. Fidelity and Vangaurd also have good lifecycle funds,

You won't go wrong with some mix of the following:
1) Index Fund - I like the Vangaurd 500 which tracks
2) the S&P 500
3) Lifecycle Fund - with target date near your anticipated retirement.
4) 5-20% in international (less if you are older) - these can be quite risky so only use them for long term investments.
5) 5-20% in an income fund (more is you are older)

If you considder moving things around, make sure to check to see if there is a holding period. Many funds charge a % fee (maybe 1%) if you hold the fund less than a set period of time (30/60/90 days).

[Matt Spong]

If you're new to the game, or you don't have a high tolerance for risk, then stay away from options and futures. They are extremely complex instruments whose price depends on much more than simply the price of the underlying instrument (such as the strike price, time to expiration, volatility, and interest rates) and there is a complex interplay between the variables.

In addition, because they are so highly leveraged, you must scrutinize your entry and exit points very closely through careful technical analysis - fundamental analysis is nearly meaningless for the short time periods involved.

If you want to put in the effort to learn technical analysis (learn for regular stocks first!) as well as the intricacies of options, then by all means go ahead. But it's not an easy job, and there's much to consider. Once you know what you're doing, though, they can be extremely powerful investment vehicles that, when used properly, can strongly boost your returns while adding a minimum of risk (and in some cases, reducing or even entirely eliminating [though this is rare] risk). And they can greatly increase your leverage without the additional risk of investing on margin.

I'd stay away from commodity futures entirely, though. There you're playing with the big boys, and they will eat your lunch (unless you're REALLY good - you need to be nearly perfect with your technical and intramarket analysis here in order to even make any profit at all). If you really want to invest in something like gold or oil, take the safer route and invest in a gold or oil company's stock.

[Dean in Des Moines]

Agreeing with Dave H. and others. Options and futures are very complex and often seem more like Vegas than Wall Street. International markets seem under represented in your portfolio.

Gold is another critter altogether. It's heavily marketed and waaaaaaay overpriced. It isn't a long term investment tool, or a reasonable hedge against inflation. It's a gimmick or collecter's item -- like that limited-run superbowl plate you wanted back in the 80's.

[tinyhands]

Echoing the other advice, derivatives should only be employed by knowledgeable investors. I don't think the bond fund is appropriate for a young investor (although age wasn't stated, merely experience level) and the energy sector fund probably isn't appropriate for a portfolio that isn't otherwise diversified.

[Lord]

Futures and options are wasting assets, not buy and hold investments, so are speculations rather than investments. Commodities and gold are more short term plays than long term investments and will be hard hit during the next recession. I would recommend dividend and value stocks over bonds as bonds are highly overpriced.

David Swensen in 'Uncommon Success' identifies asset classes appropriate for individuals. He recommends domestic equities 30%, developed country (international) equities 15%, emerging market equities 5%, real estate 26%, treasuries 15%, tips 15%.

[John]

I'll probably start ruffling a few feathers here and state that now is likely not the best time to go into US stock index based funds. Why? Because the boomers who 'funded' them are shortly going to flip from net funders to net withdrawers and the next generation's numbers and income is likely not going to be sufficient to maintain an ever upward moving market. If you doubt this, you had best take into account the rather sudden (panic induced?) moves of increasing money supply by over 40% (then trying to hide the numbers going forward) and then (last month) lowering the margin requirements for investors and investment houses alike. Someones trying to keep a balloon from deflating too quickly, imho.

Here are a few things for you to consider regardless of locale or time:

Are domestic laws and taxation favorable to real liberty and free enterprise? Per Kyosaki, the safest people are also the poorest...and happen to be called 'prisoners'. Think about it.

Are national and area demographics tilted decidedly in favor of your investment, regardless of what the talking heads are screaming?

Is the smart money investing/re-investing in their own public corporations, or are they retrenching by buying into privately held companies and politically favored cartels? Is 'old-money' buying intellectual properties or commodity & infrastructure based properties? This will tell you which way 'the market' is headed, long term.

Are 'funds' the only secure investment available to you? You may be interested to know that the market has only returned (inflation/devaluation adjusted) a meager 5% per annum return over the long haul. So, if you haven't invested in tax free issues, you've actually lost ground in real money terms. There are many other less 'sexy' or popular investment constructs that beat the herd...you just have to seek.

The fact that you have just come into money means you have all the time in the world (unless the money devaluates) to educate yourself and come to your own conclusions. My advice? Do so. Within a year you will know more than half the so-called pro's. Within two years you will know more than the top 20% and that's when you can start really making some wise and profitable decisions. I'm in the same boat you are...and while looking for choice investements I will park my money by monating in Swiss francs (at this writting about 70% gold backed, though it is no longer a constitutional requirement) in a conservative (little to no derivative exposure) bank.

Read, Read, Read...Apply, Apply, Apply...Simplify, Simplify, Simplify. And if you still have no confidence in your own common sense...find a savvy investment person who's living off investments, not income. Listen to winners, not parasites.

Just my 2 cents. All the best to you,

John

[John]

In the second to last paragraph, where I wrote 'more than the top twenty percent' I meant 'more than all BUT the top twenty percent'. I should have just used 'more than 80%', but- hey- I'm no writer!