The risks of 'sexy investing'

When you've got big goals for your money, or when you're on a strong path with your savings and investments, it's natural to start thinking about less traditional areas for investment.

Sexy investments can have a place on your journey, but making the wrong choice is a big risk to your progress.

You'll have come across stories about people who have made big money investing in, for example, startup companies, cryptocurrency, buying gold and precious metals, and trading currencies.

These investments sound exciting, so you look further.

You find quite a few people are talking about them as the way to make serious money in a relatively short time.

Because your inner investor craves big returns as quickly as possible, these stories have an inbuilt psychological appeal. And this is where it can all go wrong.

Cryptocurrency risks

Volatility is significantly higher than for traditional investments.

This volatility is driven by a number of factors including positive and negative news about market prices, as well as the fact that a large crypto investor's need to sell their position (or buy more) can move the market and change prices significantly.

Crypto doesn't pay an income. You will benefit from investing in cryptocurrency only when you sell.

Bitcoin is held in a digital wallet, which means it is being minded by someone else. A number of crypto exchanges are based overseas, which can mean that if something goes wrong it can be harder for you to chase down your cash.

Finally, because cryptocurrency is digital, it's vulnerable to hackers.

Gold and precious metals risks

Like crypto, gold doesn't generate income. This means gold is not a good investment for someone looking to build a second passive income from investments.

Another risk is volatility.

Gold can experience much bigger, and more stressful, price swings than more traditional investments like shares or property.

Bonds risks

The first is that the company or institution that issues the bond will default.

If the issuer is someone like the US government, this risk is fairly low, but if you buy bonds in, say, a small startup, the risk can be significant.

You need to be confident the issuer is going to be around to make the interest payments and return your money when the bond comes due. While bonds are typically more stable than other investments, their value can fluctuate.

The biggest risk with investing in bonds is that they are income as opposed to growth investments.

They pay a set income return until your capital is returned at the end of the term. Because your money doesn't grow while it's sitting in the bond, inflation can take a large chunk out of your real return.

Startup investing risks

Small companies are typically new and therefore have no track record.

They have less diversified operations and fewer income streams, so internal or external risks can challenge future growth.

Many startup companies have solid internal controls and processes but because they are not subject to the strict standards of governance and regulation that apply to public companies, they may be more vulnerable to risk.

When a company looks to raise capital by selling shares, they effectively set the price at what they think the company is worth or what they think an investor might pay.

This means that if they set the price at an overly optimistic level, even if the company does continue to grow, it could take a long time for the true value of the company to catch up with the share price.

Startup companies typically don't pay dividends either, because they aren't yet profitable or because they want to reinvest profits in the company.

When you invest in a startup, you hope the company will ultimately list on the stock exchange as a publicly traded company. Until this happens, you can't actually sell your shares.

Commercial property risks

Your tenant will generally be a business, and if the business doesn't do well, your rental income can be at risk.

Changing tenants typically takes longer because the property needs to be set up specifically for the occupier. Because the value of a commercial property is linked closely to the economic cycle, values can be volatile.

When the economy is going well and businesses are growing, commercial property values go up, but when the economy struggles values generally come down.

With residential property, values tend to be driven purely by supply and demand.

Where sexy investments fit for smart investors

In my opinion, no one needs to invest in these areas. Ever.

If you go through your whole life never investing a single dollar in the kinds of investments covered here, you can comfortably become a millionaire.

In fact, you will probably get there faster with less work and less stress. But there is money to be made here if you make the right move at the right time.

The right move for you depends on the stage you're currently at with your money.

This is an edited extract from Virgin Millionaire: The step-by-step guide to your first million and beyond by Ben Nash (Wiley, $34.95).

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