Permit me to illustrate the difference between gambling and investing, which is one of the many investing lessons that my forthcoming stock advisory newsletter, The Liberty Portfolio, will deliver. When you go to a casino, you are betting money on games that are all designed to give an advantage to the casino. You may have heard the term “house edge,” which refers to the ratio of the average loss to the initial bet. What does that mean exactly?
Roulette has a house edge of 5.26%. That means that, over time, you will likely lose $5.26 of every $100 you bet. You may walk up to a roulette wheel, put $100 on a number, that number could hit, and you’d win $3,600. Not bad! It’s also a great time to run out of that casino, because if you keep playing, over time, that win is going to erode. It may take hundreds or even thousands of spins, but over time, you will end up losing $5.26 for every $100 you bet.
With gambling, you have a negative expected return over time.
Investing is very different. Investing has a positive expected return over time. The reason for this is that earnings grow over time, and like Peter Lynch says, stock prices follow earnings.
However, a lot of people are so taken by some exotic investment vehicles in the market that they think they are making great investments when in fact they are making the worst investments that exist in the market. That’s because the worst investments aren’t really investments at all, but gambles.
The Worst Investments You Can Make: iPath S&P 500 VIX Short-Term Futures (VXX)
Expenses: 0.89%, or $89 per $10,000 invested.
Let’s take the iPath S&P 500 VIX Short-Term Futures TM ETN (NYSEARCA:VXX). VXX isn’t a stock. You aren’t buying ownership in anything. There’s no sales or net income to track, no price-to-earnings ratio and no dividends.
That’s because this is nothing more than a gamble on volatility. The VXX is tied to something called the Chicago Board Options Exchange’s Volatility Index. It’s nothing more than a “barometer of investor sentiment and market volatility.” If that sounds like a wibbly-wobbly-timey-wimey thing that it difficult to peg down as far as its actual methodology, well, join the club.
But it gets worse. No security actually tracks this “barometer,” so instead, futures contracts based on this wibbly-wobbly-timey-wimey security were invented. The VIX futures themselves? Well, the VXX vehicle created to track them isn’t even very good — since it only moves about 50%-60% of what the VIX index moves. The VXX is thus this bizarre security that trades like a stock, is only moderately tied to futures contracts but has the same decay qualities of an option.
And it’s down 73% over the past year. It’s not an investment. It’s putting all your money on the wheel of fortune.
The Worst Investments You Can Make: SPDR Gold Trust (GLD)
I know gold bugs will hate me, but gold is also one of the worst investments you can make. You’ll hear radio commercials all day long about buying gold, about buying gold sovereigns and about how gold is an inflation hedge. It’s all nonsense. The thing about gold, and securities like SPDR Gold Trust (ETF) (NYSE:GLD), is that gold also doesn’t have earnings that grow over time.
GLD and other precious metals are tied to two things: supply/demand of the market, and sentiment.
Like all commodities, the demand for any given precious metal is going to depend on many factors. Most of these factors are macroeconomic. If economies are doing well, more manufacturing occurs, and demand will rise. Certain sectors may even have increased demand for gold if the macroeconomic situation is poor. But demand can wane, and with it, the price of GLD.
During the financial crisis, the price of GLD soared because people believed it to be a storehouse of value. Then the crisis abated and GLD collapsed. Gold has had negative real returns in three of the past five decades.
The Worst Investments You Can Make: CurrencyShares British Pound Sterling Trust (FXB)
Another of the world’s worst investments is currencies.
Just like gold, currencies are a function of supply and demand, as well as the macroeconomic fortunes of a given country. Not only that, they are subject to the political stability of a given country and even a given region.
There’s no investment to be made unless, like gold, you somehow manage to jump into a currency at a time when it begins a sustained upward move. That’s market timing, also known as gambling, and that is not an investment.
Currencies, like gold, may act as a hedge in certain sophisticated circumstances, but good luck on timing that investment correctly.
Think about the United Kingdom. It seems like the UK is thriving, with great economic growth, good times, and soaring real estate prices. Yet Guggenheim CurrencyShares British (NYSEARCA:FXB) has fallen about 40% since 2008.
Stay away from all of these. They are as bad as dropping money into a slot machine.
Lawrence Meyers is the CEO of PDL Capital, and manager of the forthcoming Liberty Portfolio stock newsletter. As of this writing, has no position in any stock mentioned. He has 22 years’ experience in the stock market, and has written more than 1,600 articles on investing. Lawrence Meyers can be reached at TheLibertyPortfolio@gmail.com.