What is A.M. Best Ratings and Why Should You Care?

When you are selecting an insurance company, it is important that you are aware of the insurer’s financial strength. Luckily, there are financial rating companies that do the hard work for you. One of these companies is A.M. 

Depending on the rating, you’ll be able to determine which insurance company is best for you.

It should be noted, A.M. Best is not the only rating company. There are several others, like the Fitch rating and Standard and Poors. 

A.M. Best Ratings AT A GLANCE

Year Founded

1899

Size

Largest credit rating agency in the world specializing in the insurance industry

HQ Address

Ambest Road

Oldwick, NJ 08858

United States

Phone Number

800-544-2378 

A.M. Best Company Information

So, what makes this one rating company special? They aren’t the only rating company out there, but they are the most notable and most widely used.

To quote A.M. Best, their rating system “. . . is an independent opinion of an insurer’s financial strength and ability to meet its ongoing insurance policy and contractual obligations. It is based on a comprehensive quantitative and qualitative evaluation of a company’s balance sheet, strength, operating performance and business profile.”

Aside from giving the companies a letter grade on their scale, the rating company also includes an outlook projection. They give them an outlook of either positive, negative, or stable. While these are just guesses, with A.M. Best they have research and previous information to base their outlooks on.

A.M. Best provides a way for each company to see just where they rank with consumers and helps them know just what they have to do to correct their mistakes.
Finding out what is A.M. Best ratings for insurance companies is the first step towards getting a secure policy for you and your family.

How Does A.M. Best Insurance Ratings Scale Work?

For a professional company, using a basic method of grading insurance companies has proven to be an effective and helpful tactic. Here’s how the A.M. Best Insurance rating scale works:

  • A++, A+, A, and A- all identify the top insurance companies. Receiving an A for the company shows how financially strong they are, how capable a company is of guaranteeing your policy and keeping it secure.
  • B++, B+, B, and B- ratings rank companies as good for those who can’t afford what higher ranked companies offer their services for. With a B ranking, you can depend on the company to provide a secure policy for affordable rates and rely on them to help your family get the help they need once you’re gone. For client’s knowing that your family has something to fall back on during difficult times is a welcome relief.
  • C++ and C+ are the only two scores for the C category, indicating an average insurance company. No bells or whistles attached, just a straightforward policy with straightforward premiums, a great choice for the first time you buy life insurance.
  • A ‘D’ rank is only reserved for companies that fall below A.M. Best’s minimum standards, an E rank means the company is under state supervision, and an F rank is only for companies going into liquidation. Any rating below a C shows how unreliable the company within the industry.

It’s obviously important to understand the rating scale of the insurance company before buying your life insurance.

A.M. Best Ratings For Insurance Companies

Now you have an understanding of what is A.M. Best ratings and how they work. A visit to the A.M. Best website is the perfect choice when looking for an insurance company. A company’s ranking shows just how dependable they are and if you’re getting all the benefits you should be for what you’ll pay in premiums. “What is A.M. Best ratings” is a question best asked when beginning to search for a policy, a question that can make your search easier and simpler than you originally thought.

Why A.M. Best Matters

Sure, it’s nice to find a company with an A+ rating, but does it matter? How does it impact you or your life insurance policy?

These ratings are a good indicator of how much you can trust your insurance company. If a company doesn’t have good financial strength, there is always a chance that the company could go bankrupt and your policy wouldn’t be paid out, which is a terrible turn of events.

There is no way to predict the future or what could happen to a company, but rating systems give us more direction that completely guessing. The A.M. Best ratings give you an idea of the past and stability of a company without you having to do the research yourself.

Unless you’re really connected with the insurance industry, you probably don’t know which insurance companies have been around the longest or which ones have experienced financial problems in the past.

Because life insurance is such an important purchase, it’s vital that the company that you choose is going to be around for hundreds of years to come. Life insurance gives you and your loved ones the peace of mind and financial coverage that they need in case something tragic were to happen.

How do A.M. Best Ratings Compare?

How does A.M. Best compare to other popular rating companies? A.M. Best is not the only company on the market that rates insurance. A few other popular options are Fitch and Standard and Poors.

Below we compared A.M. Best, Fitch and Standard and Poors. In this table, it is important to note that though the ratings may appear in the same row, it does not mean they are equal to each other. For example, Fitch’s AA rating may differ from Standard and Poors. 

Ratings of Insurers’ Financial Strength

A.M. Best Fitch Standard and Poors
A++, A+ AAA AAA
Superior ability to meet ongoing obligations Exceptionally strong capacity to pay financial commitments Extremely strong financial security characteristics. Highest S&P rating
Not Applicable AA AA
Companies rated A+ are one “notch” lower than those rated A++ Very strong capacity to pay financial commitments Very strong financial security characteristics
A, A- A A
Very strong capacity to meet financial commitments Strong capacity to pay financial commitment Strong financial security characteristics
B++, B+ BBB BBB
Good ability to meet financial obligations Adequate capacity to pay financial commitments Good financial security characteristics
B, B- BB BB
Fair ability to meet financial commitments Elevated vulnerability to default risk but has flexibility to service financial commitments Marginal financial security characteristics
C++, C+ B B
Marginal ability to meet their ongoing insurance obligations. Significant risk of default with limited margin of safety Weak financial security characteristics

History of A.M. Best

Alfred Best founded A.M. Best Company in 1899. A.M. Best is one of the oldest and most established rating companies in the world. They were established with the goal of reporting the financial stability of insurance companies. They currently have ratings for companies that are in more than 80 different countries across the world.

Bottom Line

When you start looking for a life insurance policy (or any other kind of insurance policy), it’s important that you look at the company’s A.M. Best rating. While their rating shouldn’t be the determining factor in your decision, it’s important to know that you’re buying a policy from a reputable company.

A faulty insurance company shouldn’t keep you from getting the coverage that you and your loved ones deserve. Don’t be one of the countless stories of a family that suffers the loss of a family member, and then learns that they have thousands of dollars of debt and no way to pay for it.

The post What is A.M. Best Ratings and Why Should You Care? appeared first on Good Financial Cents®.

Source: goodfinancialcents.com

What Is a Mortgage Refinance? 5 Ways to Know If It’s a Good Idea

Jason says:

Hi, Money Girl. I’m interested in refinancing and getting a lower interest rate on my mortgage; however, I may need to sell my home and relocate in a year or so. In that case, does a refinance still make sense? If so, what factors should I consider?

Jason, thanks for your question! It’s a perfect time for homeowners to consider refinancing because interest rates are at historic lows.

If you’re a homeowner, your mortgage payment is probably your largest monthly expense, so it’s wise to stay alert for opportunities to reduce it by refinancing. Plus, your financial circumstances and needs today may be very different than they were when you originally got your mortgage.

It’s a perfect time for homeowners to consider refinancing because interest rates are at historic lows.

I'll answer Jason’s question by reviewing what a mortgage refinance is, explaining common reasons to consider doing one, and covering five ways to know if it’s a good idea for your situation.

What is a mortgage refinance?

Refinancing is when you apply for a new loan to pay off an existing loan balance. The new loan could be with your same institution or with a different lender. The idea is to swap out a higher-interest loan for a lower-interest one, which decreases the amount of interest you have to pay and may also reduce your monthly payments.

When you take out a mortgage to buy a home, various factors determine the interest rate you get offered. While your credit, down payment, and income history are critical, lenders base mortgages on the prevailing interest rates. 

An interest rate is simply the cost of money for borrowers. Rates in the U.S. fluctuate according to the monetary policy of the Federal Reserve or Fed, which is our central bank. 

A good rule of thumb is to consider refinancing when the current rate dips at least one percentage point below what you’re paying for your mortgage.

When interest rates are low, it’s like money’s on sale, as strange as that sounds! Banks should display a big banner on their front door or website that reads “bargain basement prices on dollars” or “we sell money cheap” because that’s what happens when interest rates go down. Low rates are great for borrowers, but not so good for lenders. 

The Freddie Mac website shows historical data for interest rates on 30-year mortgages since 1971. In August 2020, the average for a fixed-rate, 30-year mortgage was 2.94%. A year earlier, the same loan was 3.62%, and ten years before, it was 4.43%. 

Since interest rates change periodically, the rate you’re currently paying on a mortgage may be significantly different than the going rate. A good rule of thumb is to consider refinancing when the current rate dips at least one percentage point below what you’re paying for your mortgage.

What’s the cost to refinance a mortgage?

You need at least one percentage point between the going rate and yours because there’s a cost to do a refinance. Closing a loan means you must pay fees to various companies, including your lender or mortgage broker, property appraiser, closing agent or attorney, and surveyor. Plus, there are fees required by the local government for recording the mortgage, and maybe more costs, depending on where you live. 

The total upfront cost of a refinance depends on the lender and property location. It could be as high as 3% to 6% of your outstanding loan balance. The trick to knowing if it’s worth it is to figure out when you’d break even on those costs. In other words, when do you go from the red to black on the deal? 

If you pay for a refinance but don’t keep your home long enough to recoup the cost, you’ll lose money. But if you do keep the property beyond the financial break-even point (BEP), you’ll feel like a genius because you saved money in the long run!

If you pay for a refinance but don’t keep your home long enough to recoup the cost, you’ll lose money.

You may be able to roll closing costs for a refinance into the new loan, which means you would have nothing or little to pay out-of-pocket. But adding them increases the amount you borrow and may also increase the interest rate you pay for the life of the loan. For that reason, it’s essential to ask the lender for a side-by-side comparison of all the terms for each loan option so you can carefully evaluate them. 

So, how do you figure the BEP to know if doing a refinance is wise? Here’s a simple BEP formula: Refinance break-even point = Total closing costs / Monthly savings.

For instance, if your closing costs are $5,000 and you save $150 a month on your mortgage payment by refinancing, it would take 34 months or almost three years to recoup the cost. The calculation is $5,000 total costs / $150 savings per month = 33.3 months to break even.

For help crunching your numbers, check out the Refinance Breakeven Calculator at dinkytown.com.

Since how long you own your home after a refinance is critical for making it worthwhile, I’m glad that Jason brought it up in his question. For instance, if he finds out that he’d need to own his home for five years to break-even, but he only plans on staying in it for two years, that should be a deal-breaker.

How to get approved for a mortgage refinance

If you believe that doing a refinance could be wise, you’ll also need to consider if you qualify. Lenders have different underwriting requirements, but most require you to have a minimum amount of equity in your property.

Equity is the difference between your home’s market value today and what you owe on it. A critical ratio for refinancing is known as the loan-to-value or LTV.

For example, if your home value is $300,000 and you have a $150,000 mortgage outstanding, you have $150,000 in equity, an LTV ratio of 50%. But if you owed $250,000, that would be an LTV of 83%. 

You typically need an LTV less than 80% to qualify for a mortgage refinance.

You typically need an LTV less than 80% to qualify for a mortgage refinance. So, Jason should do some quick math to make sure he doesn’t owe more for his home than this threshold based on the current market value. Lenders may still work with you if you have a high LTV and good credit, but they may charge a higher interest rate.

If you have an existing FHA or VA mortgage, you may qualify for a “streamlined” refinance program that requires less paperwork and less equity than a conventional refinance. Check out the FHA Refinance program and the VA Refinance program to learn more.

Reasons to consider refinancing your mortgage

There are a variety of reasons why it may make sense for you to refinance a mortgage. Here are some situations when doing a refinance may be a good solution.

  • Rate-and-term refinance. This is when you get a new loan with a lower interest rate, a different term (length of the loan), or both. It’s probably the most common reason why homeowners refinance their mortgages. 

    Example: If you have a 30-year, fixed-rate mortgage at 5%, you could refinance with a 30-year mortgage at 3%. That would reduce your monthly payments and the amount of interest you pay over the life of the loan.
     

  • Cash-out refinance. This is when you get a larger loan than your existing mortgage, so you walk away from the closing with cash. 

    Example: Let’s say your home’s market value is $200,000, and your mortgage balance is $100,000. If you need $25,000 to pay for college or renovate your home, you could do a cash-out refinance for $125,000. After paying off the original mortgage of $100,000, you’d have $25,000 left over to spend any way you like.  
     

  • Cash-in refinance. This is when you pay cash at the closing to pay off an existing mortgage balance. That could be necessary if you don’t have enough equity to qualify for a refinance, or you owe more than your home is worth. 

    Example: You might do a cash-in refinance if having a lower LTV qualifies you for a lower mortgage rate or allows you to get rid of private mortgage insurance (PMI) payments. Read or listen to How to Avoid PMI on Your Home Loan for more information.

You may also need to refinance a mortgage if you want to remove a co-borrower, such as an ex-spouse, from your loan. But if one spouse doesn’t have sufficient income and credit to qualify for a refinance on his or her own, your best option may be to sell the property instead of refinancing the mortgage.

5 ways to know if it’s the right time to refinance

Here are five ways to know if doing a rate-and-term refinance is a good idea.

1. You have an adjustable-rate mortgage (ARM)

Buying a home with an adjustable-rate mortgage comes with lots of advantages like a lower rate, a lower monthly payment, and being able to qualify for a larger loan compared to a fixed-rate mortgage. With an ARM, when interest rates go down, your monthly payments get smaller. 

Instead of worrying about how high your adjustable-rate payment could go, you might refinance to a fixed-rate loan.

But when ARM rates go up, you can feel panicked as your mortgage payment increases month after month. There are caps on annual increases, but your rate could double within just a few years if rates have a significant spike.

Instead of worrying about how high your adjustable-rate payment could go, you might refinance to a fixed-rate loan. That move would lock in a reasonable rate that will never change and make it easier to manage money and stick to a spending plan.

2. You could get a lower interest rate

If you bought a home when mortgage rates were higher than they are now, you’re in a great position to consider refinancing. As I mentioned, you need to do your homework to understand the cost and BEP fully. 

I recommend shopping for a refinance with the lender who holds your current mortgage, plus one or two different companies. Let your mortgage company know that you’re shopping for the best offer. They may be willing to waive specific fees if some of the necessary work, such as a title search, survey, or appraisal, is still current for your home.

3. You don’t plan on moving for several years

Once you know what a refinance will cost, make sure you’ll own your home long enough to pass the BEP, or you’ll end up losing money. For most homeowners, it typically takes owning your home for at least three years after a refinance to make it worthwhile.

4. You have enough home equity

As I mentioned, you typically need at least 20% equity to qualify for a refinance. If you have less, you may still find lenders that will work with you. However, unless your credit is excellent, you’ll typically pay a higher interest rate when you have low equity.

Also, if you don’t have 20% equity, lenders charge PMI. Adding that to your new loan could cut your savings and give you a much longer break-even point. 

5. Your finances are in good shape.

The higher your income and credit, and the lower your debt, the better your refinancing terms will be. If you’re unemployed or your credit took a dive due to a hardship, wait until your overall financial situation has improved before making a mortgage application. Good credit can save thousands in mortgage interest.

Good credit can save thousands in mortgage interest.

If you investigate doing a refinance and decide that it’s not worth the cost, another strategy to save money is to ask your lender for a mortgage modification on your existing loan. You may be able to negotiate modified terms, such as a lower interest rate, without having to pay for a full-blown refinance.

If you’re unsure how much home equity you have or know that you have very little, don’t let that stop you from inquiring about your refinancing options and saving money. Getting advice and refinancing quotes from your lender is free and will help you understand your range of financial options.

Source: quickanddirtytips.com

Looking for Auto Insurance? Here Are 6 Things You Need to Know

Let’s get one thing out there: no one is especially psyched to get car insurance. You get it because it’s a financial safeguard against damage to your car or injury to you or others (and maybe because it also happens to be legally required in some form nearly everywhere in the US). Car insurance is complicated, and drivers often don’t know what to expect from the process.

Let us break down the basics so you’re better able to find the right coverage for you. Here are six things you need to know.

1. What Car Insurance Is 

As a licensed insurance agent, I find that many people I talk to don’t quite understand what insurance is or why they need it. I get it. After all, insurance is rather abstract—it’s not a physical object you buy at a store. Further, if all goes well for you, you won’t ever have to use the coverage you paid for. So it’s often hard for people to see the value.

In the simplest terms, insurance is a promise from an insurance company to support you financially in the event that something unfortunate occurs and causes you financial loss or other damage. You pay an insurance company money (your premium) for a policy that details your coverage (who/what is protected and to what dollar amount), and the insurance company is responsible for paying if something happens and you incur a loss (damage to your car, a broken leg, etc.). Insurance companies do this by pooling risk among all the people they insure, collecting premiums from everyone and using those funds to pay claims for those who need it.

Of course, there are many other details that go into the whole system, but we’re keeping it simple.

2. What Different Insurance Types Cover

The type and amount of coverage each person needs varies, but these are the coverage basics you should know.

Liability coverage is legally required for drivers in almost every state. It covers the other driver in a crash you cause, and it includes injury and property damage. If you see numbers like 25/50/10 or 30/60/25, that shows the liability coverage limits for (1) bodily injury per person, (2) bodily injury per accident, and (3) property damage—each in thousands of dollars. For example, 25/50/10 means your coverage will extend up to $25,000 per individual injured in an accident, $50,000 for all persons injured in an accident, and $10,000 for property damage.

In no-fault states, you are required to carry coverage (normally personal injury protection or PIP) for your injuries regardless of who caused the accident.

Collision coverage, which covers damage caused in a crash, and comprehensive coverage, which covers damage from other events including weather (fire, flooding, etc.) as well as theft, are often collectively called full coverage.

Other coverages include uninsured motorist coverage, which protects you and your vehicle from damage caused by people who don’t have insurance, and medical payments coverage, which covers select costs for injuries you and your passengers sustain in a collision.

3. How to Get Car Insurance

You can easily go online, call a company or two, or even walk into a local insurance agent’s office to talk to them about getting coverage. But how do you know which company to contact?

Insurance companies spend billions of dollars every year on advertising, so you could probably rattle off a few big car insurance brands you’re familiar with. But it’s important for consumers to know that not all insurance companies are the same—in fact, they all have different ways of pricing policies, and many look for certain types of customers with certain risk profiles to do business with.

This is why it’s more important than ever to compare car insurance quotes from as many companies as possible. Getting multiple opinions and understanding the market will help you find the best rate around.

4. Why You Pay What You Do

Insurance companies determine what you pay for insurance based on dozens of “rating factors”—all having to do with who you are, where you live, what you drive, and other details of your history, both on and off the road. Everything is about statistics, and insurance companies assign certain levels of risk to each of these factors to gauge the likelihood that you will file a claim.

For example, teens are considered high-risk drivers because they have so little experience behind the wheel and are statistically likelier to be in an accident—and thus file more claims—than older drivers, so they often pay much more for their premiums.

Other risk indicators include some obvious ones (like your driving record) and some less-obvious ones (like your ZIP code). There are also certain factors, like your credit score, which only some states allow to be used in determining your rate (it’s prohibited in California, Hawaii, and Massachusetts).

5. How to Lower Your Risk and Your Rates in the Future

You can’t change certain insurance rating factors, like your age, but you can make a few changes to reduce your risk in other areas. Here are a few tips:

  • Drive safely and maintain a clean driving record.
  • Consider sharing a policy with someone you live with.
  • Bundle your renters or homeowners policy if you can.
  • Pay your premium in full at the start of your policy or sign up for auto-pay.
  • Maintain insurance coverage with no lapse between policies (even for a day).

6. When to Get Insurance 

The obvious time to get car insurance is when you’re getting a car, but it’s critical that you don’t have a lapse in coverage between insurance policy terms. I highly recommend shopping around for car insurance before you begin the car-buying process. Shopping early also allows you to account for your premium in your car-related expense budget.

Other times to switch insurance could be if you get married, move, or have another big event in your life; if your rates increase for no apparent reason; or if you need to add a new teen driver to your policy.

Additionally, it’s important to compare rates every six months to make sure you’re staying up to date on any changes that might occur if you move, get a speeding ticket, or even have a birthday.

Once you’re ready to start your insurance search, you can use Credit.com’s comparison tool to get a car insurance quote and compare rates.

Image: istock

The post Looking for Auto Insurance? Here Are 6 Things You Need to Know appeared first on Credit.com.

Source: credit.com

A Guide to Coinsurance and Copays

You often pay your copay when you check in for a visit.

Having health insurance makes it possible to receive medical care while only paying a fraction of that care’s true cost. Insurance doesn’t cover everything, however. Some of the cost of your care is still up to you to pay, and that cost comes in two primary forms: copays and coinsurance.

What Is a Copay?

A copay is a flat amount of money that you’re responsible for paying for a health care service. Copays typically apply for things like a doctor’s appointment, prescription drug or medical test. The amount of your copay is dependent on your specific health insurance plan.

You can typically expect to pay your copay when you check in for your service, be it an annual physical, dental cleaning or blood test. Copays are typically lower amounts ranging from $10 for something like a generic drug prescription to around $65 for a visit to a medical specialist.

Depending on your insurance plan, copays may not take effect until after you reach your deductible. Your deductible is the amount of money you must pay out-of-pocket before your insurance provider starts to pitch in. Deductibles reset at the beginning of every year.

When you are reviewing your plan information and you see the phrase “after deductible” or “deductible applies” in reference to your copays, that’s an indication that the copay is only in place once you meet your deductible. On the other hand, if you see “deductible waived,” that’s a sign that your copay is in place from the beginning. It may go without saying, but the latter situation is vastly preferable to you.

What Is Coinsurance?

Coinsurance is another method of splitting the cost of medical coverage with your insurance plan. A coinsurance is a percentage of the cost of services. You pay the percentage, and your insurance company foots the rest of the bill. So, if you have a $8,000 medical bill and a 20% coinsurance, you would be on the hook for $1,600.

Coinsurance typically only comes into play after you hit your deductible. Further, you may have differing coinsurance percentages for the same services depending on your provider network. If you have a preferred provider organization (PPO) plan, your coinsurance could be a higher percentage for providers outside your network than it is for providers in your network.

Similarly, your coinsurance may not apply to providers outside your network if you have a health maintenance organization (HMO) plan or an exclusive provider organization (EPO) plan. That’s because these plans typically don’t provide any out-of-network coverage.

Copay vs. Coinsurance

You likely pay a copay when you visit the doctor.

Copay and coinsurance are very similar terms. They both have to do with portions of the cost of your health care that’s under your responsibility. Because of that, and their similar names, it’s easy to confuse the two. There are a couple of important distinctions to keep in mind, however.

The most notable difference between copays and coinsurance is that copays are always a flat amount and coinsurance is always a percentage of the cost of the service. Another difference is that some copays can be in place before you hit your deductible, depending on the specifics of your plan. With coinsurance, you have to hit your deductible first.

Bottom Line

copays are fixed amounts, while coinsurance is a percentage.

If you’re choosing between health insurance plans, make sure to examine the provided copays and coinsurance for each option. While they may not be the most important factor to consider, a high copay can be quite a pain, especially over the course of years of appointments and procedures.

Tips for Staying on Top of Medical Expenses

  • One of the best ways to stay ahead of surprise medical expenses is to have an emergency fund in place for just such a situation. If you can manage it, have three to six months worth of expenses stashed away in a high-yield savings account. That way, if you’re dealing with medical bills or have to step away from work, you’ll have a bit of a cushion.
  • If you’re not sure how an unexpected medical expenses would fit into your finances, consider working with a financial advisor to develop a financial plan. Finding the right financial advisor that fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in 5 minutes. If you’re ready to be matched with local advisors that will help you achieve your financial goals, get started now.

Photo Credit: ©iStock.com/DuxX, Â©iStock.com/SARINYAPINNGAM, Â©iStock.com/Aja Koska

The post A Guide to Coinsurance and Copays appeared first on SmartAsset Blog.

Source: smartasset.com

10 Risky Investments That Could Make You Lose Everything

If the stock market crashed again, would you respond by investing more? Is day trading your sport of choice? Do you smirk at the idea of keeping money in a savings account instead of investing it?

If you answered yes to these questions, you’re probably an investor with a high risk tolerance.

Hold up, Evel Knievel.

It’s fine to embrace a “no-risk, no-reward” philosophy. But some investments are so high-risk that they aren’t worth the rewards.

10 Risky Investments That Could Lead to Huge Losses

We’re not saying no one should ever consider investing in any of the following. But even if you’re a personal finance daredevil, these investments should give you serious pause.

Sure, if things go well, you’d make money — lots of it. But if things go south, the potential losses are huge. In some cases, you could lose your entire investment.

1. Penny Stocks

There’s usually a good reason penny stocks are so cheap. Often they have zero history of earning a profit. Or they’ve run into trouble and have been delisted by a major stock exchange.

Penny stocks usually trade infrequently, meaning you could have trouble selling your shares if you want to get out. And because the issuing company is small, a single piece of good or bad news can make or break it.

Fraud is also rampant in the penny stock world. One common tactic is the “pump and dump.” Scammers create false hype, often using investing websites and newsletters, to pump up the price. Then they dump their shares on unknowing investors.

2. IPOs

You and I probably aren’t rich or connected enough to invest in an IPO, or initial public offering, at its actual offering price. That’s usually reserved for company insiders and investors with deep pockets.

Instead, we’re more likely to be swayed by the hype that a popular company gets when it goes public and the shares start trading on the stock market. Then, we’re at risk of paying overinflated prices because we think we’re buying the next Amazon.

But don’t assume that a company is profitable just because its CEO is ringing the opening bell on Wall Street. Many companies that go public have yet to make money.

The average first-day returns of a newly public company have consistently been between 10% to 20% since the 1990s, according to a 2019 report by investment firm UBS. But after five years, about 60% of IPOs had negative total returns.

3. Bitcoin

Proponents of bitcoin believe the cryptocurrency will eventually become a widespread way to pay for things. But its usage now as an actual way to pay for things remains extremely limited.

For now, bitcoin remains a speculative investment. People invest in it primarily because they think other investors will continue to drive up the price, not because they see value in it.

All that speculation creates wild price fluctuations. In December 2017, bitcoin peaked at nearly $20,000 per coin, then plummeted in 2018 to well below $4,000. That volatility makes bitcoin useless as a currency, as Bankrate’s James Royal writes.

Unless you can afford to part ways with a huge percentage of your investment, bitcoin is best avoided.

4. Anything You Buy on Margin

Margining gives you more money to invest, which sounds like a win. You borrow money from your broker using the stocks you own as collateral. Of course, you have to pay your broker back, plus interest.

If it goes well, you amplify your returns. But when margining goes badly, it can end really, really badly.

Suppose you buy $5,000 of stock and it drops 50%. Normally, you’d lose $2,500.

But if you’d put down $2,500 of your own money to buy the stock and used margin for the other 50%? You’d be left with $0 because you’d have to use the remaining $2,500 to pay back your broker.

That 50% drop has wiped out 100% of your investment — and that’s before we account for interest.

5. Leveraged ETFs

Buying a leveraged ETF is like margaining on steroids.

Like regular exchange-traded funds, or ETFs, leveraged ETFs give you a bundle of investments designed to mirror a stock index. But leveraged ETFs seek to earn two or three times the benchmark index by using a bunch of complicated financing maneuvers that give you greater exposure.

Essentially, a leveraged ETF that aims for twice the benchmark index’s returns (known as a 2x leveraged ETF) is letting you invest $2 for every $1 you’ve actually invested.

We won’t bore you with the nitty-gritty, but the risk here is similar to buying stocks on margin: It can lead to big profits but it can also magnify your losses.

But here’s what’s especially tricky about leveraged ETFs: They’re required to rebalance every day to reflect the makeup of the underlying index. That means you can’t sit back and enjoy the long-haul growth. Every day, you’re essentially investing in a different product.

For this reason, leveraged ETFs are only appropriate for day traders — specifically, day traders with very deep pockets who can stomach huge losses.

6. Collectibles

A lot of people collect cars, stamps, art, even Pokemon cards as a hobby. But some collectors hope their hobby will turn into a profitable investment.

It’s OK to spend a reasonable amount of money curating that collection if you enjoy it. But if your plans are contingent on selling the collection for a profit someday, you’re taking a big risk.

Collectibles are illiquid assets. That’s a jargony way of saying they’re often hard to sell.

If you need to cash out, you may not be able to find a buyer. Or you may need to sell at a steep discount. It’s also hard to figure out the actual value of collectibles. After all, there’s no New York Stock Exchange for Pokemon cards. And if you do sell, you’ll pay 28% tax on the gains. Stocks held long-term, on the other hand, are taxed at 15% for most middle-income earners.

Plus, there’s also the risk of losing your entire investment if your collection is physically destroyed.

7. Junk Bonds

If you have a low credit score, you’ll pay a high interest rate when you borrow money because banks think there’s a good chance you won’t pay them back. With corporations, it works the same way.

Companies issue bonds when they need to take on debt. The higher their risk of defaulting, the more interest they pay to those who invest in bonds. Junk bonds are the riskiest of bonds.

If you own bonds in a company that ends up declaring bankruptcy, you could lose your entire investment. Secured creditors — the ones whose claim is backed by actual property, like a bank that holds a mortgage — get paid back 100% in bankruptcy court before bondholders get anything.

8. Shares of a Bankrupt Company

Bondholders may be left empty-handed when a corporation declares bankruptcy. But guess who’s dead last in terms of priority for who gets paid? Common shareholders.

Secured creditors, bondholders and owners of preferred stock (it’s kind of like a stock/bond hybrid) all get paid in full before shareholders get a dime.

Typically when a company files for bankruptcy, its stock prices crash. Yet recently, eager investors have flocked in to buy those ultracheap shares and temporarily driven up the prices. (Ahem, ahem: Hertz.)

That post-bankruptcy filing surge is usually a temporary case of FOMO. Remember: The likelihood that those shares will eventually be worth $0 is high.

You may be planning on turning a quick profit during the run-up, but the spike in share prices is usually short-lived. If you don’t get the timing exactly right here, you could lose big when the uptick reverses.

9. Gold and Silver

If you’re worried about the stock market or high inflation, you may be tempted to invest in gold or silver.

Both precious metals are often thought of as hedges against a bear market because they’ve held their value throughout history. Plus in uncertain times, many investors seek out tangible assets, i.e., stuff you can touch.

Having a small amount invested in gold and silver can help you diversify your portfolio. But anything above 5% to 10% is risky.

Both gold and silver are highly volatile. Gold is much rarer, so discovery of a new source can bring down its price. Silver is even more volatile than gold because the value of its supply is much smaller. That means small price changes have a bigger impact. Both metals tend to underperform the S&P 500 in the long term.

The riskiest way to invest in gold and silver is by buying the physical metals because they’re difficult to store and sell. A less risky way to invest is by purchasing a gold or silver ETF that contains a variety of assets, such as mining company stocks and physical metals.

10. Options Trading

Options give you the right to buy or sell a stock at a certain price before a certain date. The right to buy is a call. You buy a call when you think a stock price will rise. The right to sell is a put. You buy a put when you think a stock price will drop.

What makes options trading unique is that there’s one clear winner and one clear loser. With most investments, you can sell for a profit to an investor who also goes on to sell at a profit. Hypothetically, this can continue forever.

But suppose you buy a call or a put. If your bet was correct, you exercise the option. You get to buy a winning stock at a bargain price, or you get to offload a tanking stock at a premium price. If you lose, you’re out the entire amount you paid for the option.

Options trading gets even riskier, though, when you’re the one selling the call or put. When you win, you pocket the entire amount you were paid.

But if you end up on the losing side: You could have to pay that high price for the stock that just crashed or sell a soaring stock at a deep discount.

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What Are the Signs That an Investment Is Too Risky?

The 10 things we just described certainly aren’t the only risky investments out there. So let’s review some common themes. Consider any of these traits a red flag when you’re making an investment decision.

  • They’re confusing. Are you perplexed by bitcoin and options trading? So is pretty much everyone else.If you don’t understand how something works, it’s a sign you shouldn’t invest in it.
  • They’re volatile. Dramatic price swings may be exciting compared with the tried-and-true approach of investing across the stock market. But investing is downright dangerous when everything hinges on getting the timing just right.
  • The price is way too low. Just because an investment is cheap doesn’t mean it’s a good value.
  • The price is way too high. Before you invest in the latest hype, ask yourself if the investment actually delivers value. Or are the high prices based on speculation?

The bottom line: If you can afford to put a small amount of money in high-risk investments just for the thrill of it, fine — as long as you can deal with losing it all.

Robin Hartill is a certified financial planner and a senior editor at The Penny Hoarder. She writes the Dear Penny personal finance advice column. Send your tricky money questions to DearPenny@thepennyhoarder.com.

This was originally published on The Penny Hoarder, which helps millions of readers worldwide earn and save money by sharing unique job opportunities, personal stories, freebies and more. The Inc. 5000 ranked The Penny Hoarder as the fastest-growing private media company in the U.S. in 2017.

Source: thepennyhoarder.com

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