Don't Fall for Exotic Investments

The more complicated an investment strategy, the more opportunity there is for something bad to happen.

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Adam Bold
Have you heard about the hippest, trendiest new investment? In early March, Credit Suisse launched an exchange-traded note (ETN) called 2x Monthly Leveraged Credit Suisse Merger Arbitrage Liquid Index (symbol CSMB) with the celebratory ringing of the opening bell at the New York Stock Exchange. It's "the first product to provide 2x monthly leveraged exposure to the merger arbitrage strategy in an exchange-traded format," according to the press release.

When I saw this, alarm bells went off in my head. I wondered how many investors really need this product. How does it work? What the heck is it? The press release is filled with so much gobbledygook it's hard to tell.

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If we've learned anything from the financial crisis of 2008, it's this: The more complicated an investment strategy, the more opportunity there is for something bad to happen. Remember collateralized debt obligations? Banks and other investment firms bought these leveraged portfolios of sub-prime mortgages, which carried higher interest rates than regular mortgages. They worked fine until the bubble in the housing market burst.

Another example is auction-rate preferred securities, which were sold as an alternative to money market funds. These products also ran into trouble during the credit crisis.

I realize that my investment strategy of using no-load mutual funds and asset allocation—spreading your money among different investment types and rebalancing regularly—is boring. It's about as entertaining as watching paint dry.

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However, our strategy works well during any market condition. The mutual funds we use are sensible in good times and bad. Yes, stock funds lost money during the financial crisis, but they came back. And I can explain to investors how other types of funds were able to help offset stock declines.

I understand how investors can get bored when they hear about the same strategy and investments over and over again. After I broke my elbow, at first I told people exactly what happened. I was rollerblading with my daughter and trying to show off by spinning around when I fell and landed on my elbow. Before long, I got tired of telling the real story and getting the same response that it was a stupid thing to do. So I came up with some crazy explanations, like I fell while repairing a solar panel on the Space Shuttle. I did it just to be funny.

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Wall Street likes to invent new schemes for investors, too. But the latest and exotic investments like the Credit Suisse ETN really aren't funny. This is your money and you shouldn't mess around with it.

Remember, just because a product is sounds cool doesn't mean it's a good investment. If your advisor can't explain the strategy and make-up of securities, or you don't understand the investment after listening to the explanation or reading the prospectus, I urge you to look for investments and an investment strategy you understand.

Adam Bold is the founder of The Mutual Fund Store, which provides fee-only investment advice with locations coast-to-coast. He's also host of The Mutual Fund Show, a call-in radio program broadcast across the country. Bold is author of the book The Bold Truth about Investing (April 2009). Bold is Chief Investment Officer of The Mutual Fund Research Center, an SEC-registered investment adviser, which provides mutual fund and asset allocation recommendations, and research to stores in The Mutual Fund Store system.