7 Types of Investments Clients Should Avoid: Advisors' Advice

2. Real Estate Investment Trusts

We are advising our clients to stay away from REITs. Real estate investment trusts, or REITs, are mutual funds that invest in companies that operate shopping malls, office buildings and apartments.

Shopping malls are entering foreclosure left and right, as online shopping increases in popularity.

Office vacancy rates have soared to 17% nationwide, as more people continue working from home. In Arlington, Virginia, where our firm operates, office vacancy rates have climbed to more than 23% in the first quarter of 2023.

Plummeting office building values and higher interest rates are making it harder to refinance, increasing the likelihood of foreclosure. Commercial mortgages are designed to be refinanced since the borrowing period is shorter with large balloon payments at the end.

— Alvin Carlos, financial planner and managing partner, District Capital Management

3. Penny Stocks

I usually would not recommend average investors owning penny stocks in their portfolios. Penny stocks usually have high risk, low price — usually for a good reason — low market capitalization, and are often traded over the counter, which means they are not easy to buy and sell.

Inexperienced investors may think it is a low cost investment with a high upside potential. However, aside from being highly speculative, penny stocks can be targets of pump-and-dump schemes where scammers lure inexperienced investors to invest in the stock by promoting the stock and the scammers dump their shares for a profit, leaving later stage investors in huge loss.

Therefore, penny stock usually would not fit into an average investor's investment portfolio and I have never recommended it to clients.

— Kristy Jiayi Xu, founder, Global Wealth Harbor LLC

4. Leveraged ETFs

I recently met with a prospective client who wanted a checkup on his self-managed investments. I noticed an ETF that definitely did not belong in his portfolio. He had been invested in a triple leveraged ETF for over a year.

I recommend that all investors avoid these funds as the risk far outweighs the expected returns. First, most of these strategies are not intended to multiply the performance of a benchmark over time, but on a daily basis; the managers themselves will tell you they’re not intended as long-term holdings.

Down days quickly erode capital because it takes a much larger “up day” to recover from a “down day.” Second, to achieve the leverage needed to track a benchmark by a multiple, fund managers trade derivatives daily and close positions daily to meet their objective, which imposes implicit costs from trading well above the stated expense ratios, further eroding capital.

In general, leveraged ETFs are designed to be actively traded; with my financial planning clients, I discourage active trading in favor of widely-diversified portfolios that match their return goals with the minimum amount of risk possible.

— Drew Wessell, financial advisor, Fiduciary Financial Advisors

5. Investments They Don't Understand

I advise my clients to avoid investing in things they do not understand. If they do not fully understand the investment then how are they able to decide if it is a good or poor investment?

— Heath Biller, financial advisor, Fiduciary Financial Advisors

6. Commodities

Everyday investors should avoid commodities. Commodities can be one of the most effective tools for diversification, but exposure is typically done in futures markets — derivatives — rather than by buying the actual commodity. As a result, executing a commodities strategy can be ridden with landmines and nuances of trading futures. This market should be left to professionals that have experience trading derivatives.

— Noah Damsky, principal, Marina Wealth Advisors

7. Individual Muni Bonds

An investment I often see in retail investor portfolios is individual municipal bonds. The preferential tax treatment of municipals can be attractive for those in higher tax brackets. I caution my clients that getting this exposure through individual bonds is more costly than they realize and unnecessarily risky.

While default risk is low in this asset class, it does happen. More commonly, liquidity is a concern, particularly when the credit is downgraded or otherwise the recipient of bad press. An unseen cost is the wider bid-ask spreads for these bonds when trading for retail clients. Investors can get the tax benefits while limiting these downside risks by investing instead in state-specific or national ETF municipal bond funds.

— Joe Petry, founder and financial planner, Mayfair Financial