Beware of Investments that Aren't Really Investments

I had an interesting conversation with a prospective new physician client last week about his investment portfolio.

During these consultations, I like to find out how you are managing your portfolio—whether you’re doing it yourself or you’ve hired a financial advisor. It helps me determine whether you or your advisor are making big mistakes and, also, whether I can help you fix those mistakes and get you on the right track.

Within a few minutes it was very apparent that this physician’s portfolio was total chaos.

There were so many mistakes that by the end of the conversation I had to take 800mg Motrin just so I could get rid of the headache from trying to grasp the magnitude of what I had heard.

The sad thing is that he’s working with a financial advisor.

For now, let me share with you one example of a specific holding in his investment portfolio.

This physician follows the financial news—more like financial porn—daily. Periodically, the financial media discusses the VIX, which is the Chicago Board of Options Market Volatility Index. Some people refer to it as the fear index because it measures the volatility of S&P 500 Index options.

I don’t have time to discuss options and all that (and, quite frankly, you don’t need to know about options anyway to be a successful long-term investor), but the basic concept is that the VIX is a measure of the market’s expectation of the US stock market volatility (as represented by S&P 500 Index) over the next 30 days. It’s actually more complex than this, but the idea is that the higher the VIX percentage, the higher the index option markets expect the US stock market to move up or down in the next 30 days.

It turns out there is a financial product that was created to “invest” in the VIX. It’s an exchange-traded note (ETN) whose ticker symbol is VXX.

So when you buy shares of VXX, your return is supposed to approximate the percentage return of the VIX.

Sounds kinda complicated doesn’t it?

Quite frankly, this isn’t an investment. It has the illusion of being one because a financial institution created a product to sell and disguised it as being an investment.

You see, an investment has an expected rate of return based on the risk that you take. It’s risk that drives returns. The academic studies show that only certain types of risk reward you with returns over the long term.

The expected volatility of the S&P 500 over the next 30 days—the VIX—is NOT one of the risk factors that drives returns in your investment portfolio. If you’re fearful of the stock market, you probably shouldn’t be in it to begin with—or you should tone down the risk in your portfolio by toning down your exposure to the risks that drive returns.

Investing in a fear index makes no sense.

If you or your financial advisor is dumping money in the VIX or another financial product that does not provide exposure to the risk factors that drive your portfolio’s returns, then you are gambling not investing.

Don’t take my word for it, though.

Here are the returns of VXX over the past few years:

2010: -72%

2011: -5%

2012: -77%

2013: -66%

The word that immediately pops into my mind to describe this is “decimation.”

If you don’t care about your hard-earned money, then go ahead and “invest” in financial products that are designed to solve a problem that doesn’t exist.

On the other hand, if you want a prudent investment philosophy and strategy based on the conclusions of academic studies and financial science, then chuck your speculative investment products, fire the advisor who sold them to you, and get a real investment plan.

Look through your investment portfolio and try to sniff out which holdings are just financial products that have been sold to you or disguised as investments and which ones are the real deal.