Q: I’ve been reading about a few investment platforms (which I can register for online) that allow me to manage my own investments with relative ease. The platforms advertised seem to offer products producing very high annual returns, some of which I am not familiar with, such as Binary Options and Contracts for Difference (CFDs).
Could you explain a bit more about these types of products and let me know if they are suitable for retail investors?
Sven Roering, Managing Partner at Tenzing Pacific Investment Management, advises:
A: In the age of the internet, more and more individuals are signing up for investment, securities and trading accounts online. This has unleashed a new ‘DIY age’ when it comes to personal investing, giving individuals direct access to capital markets, and ultimately leading to the improvement of the global economy.
The downside, however, is that the internet also creates a platform for opportunistic service providers to create products and services which are designed to dupe customers explicitly, or are marketed as being relatively low-risk and suitable for individuals to purchase directly, when they are actually extremely complex and not suitable for the general public.
Binary options – the buts
Binary options are the proverbial ‘new kid on the block’ when it comes to investment products. Platforms offering binary options are marketed aggressively on the internet, and often contain testimonials from customers who claim to make $5,000 per week from trading while sitting on the sofa.
The truth is that the outcome from investing in these products is, by definition, binary i.e. you place a bet and you will experience one of two outcomes:
- win some money
- lose the entire amount which you have invested
The outcome is much like betting on the winner of a football match, which is why many countries regulate binary options as gambling products and not as financial instruments.
The mechanics of a binary option are fairly simple. Here’s an example:
- An investor pay $100 for a contract with a provider that states that if there is a positive move in the price of Apple shares between 11:00 – 11:10AM, you will receive $1,000
- But if the share price has no movement, or is negative during that time, you will receive nothing and lose the amount of your initial investment
There are many different return outcomes available for trading on many different underlying securities. I would recommend doing extensive research before doing this type of trading, specifically on the platform itself, as many are blatant scams.
Contracts for Difference – or the casino?
Also know as CFDS, Contracts for Difference are more conventional investing instruments and have been around for longer than binary options. They are also far more regulated, and give investors to the option to profit from moves in a company’s share price without having to physically own the shares. These contracts are bought directly from a broker, and allow investors to profit from indirectly owning a specific amount of company shares by only contributing a fraction of what the shares would cost collectively.
- You believe that Amazon is the best, most innovative company in the world and you would like to own Amazon shares
- The catch is that you only have $100 in life savings and one share of Amazon costs around $900
- You could then use a CFD where you are only required to deposit as low as 2% of the total value of the transaction you desire
- Therefore, with your $100, you would be given indirect exposure to $5,000 worth of Amazon shares
- If Amazon shares increase by 1% in value during that specific trading day, your ‘indirect’ investment value will grow from $5,000 to $5,050 and you will pocket the difference of $50
- So, on a small $100 investment, you have made $50 profit on your favorite company, which is an equivalent to a 50% return for you
The main pitfall with this type of investing is that it carries a high risk of permanent capital loss, and the trading fees are very high.
Signing up for any type of exotic investment online might seem easy and convenient, but the pitfalls are prevalent and perilous. If you are going to dabble in this dubius world, use your casino or golf funds rather than your life savings.
For independent, professional financial advice, don’t hesitate to get in touch with TPIM for private wealth management across Southeast Asia and beyond: http://tpim.co/contact-us/.