One is the loneliest number.
One stock, one property, one cryptocurrency, one precious metal…
As you look for new opportunities to park (and grow) your money, you might be wondering if pooled investments make sense as an investing strategy, and if now is the right time to be involved.
There are pros and cons to pooled investments, and by outlining them systematically, you’ll be able to gauge whether this type of investment is right for you.
Even if you’re a highly experienced investor and you know pooled investments inside and out, it’s worth reviewing this list to see if it changes your mind.
What is a Pooled Investment?
A pooled investment is when people pool their money together and entrust with a professional fund manager. The most common types of pooled investments are:
– Mutual funds
– Hedge funds
– Exchange-Traded Funds (ETFs)
– Pension Funds
– Unit Investment Trusts
One of the biggest criticisms of pooled investments is that, as an investor, you lack control. You don’t get to pick the assets in a fund, and there could be times when the decisions that the fund manager makes benefit the group at your expense.
The good news is that most pooled investments are easy to get out of. If you don’t like what the fund manager is doing, you can sell your share and exit the investment. However, this isn’t always the case. If you are in a pooled real estate investment, the general partner calls the shots and can prevent you from pulling out. An unscrupulous or incompetent partner could cause you to lose your entire investment.
Other potential pitfalls include:
Liquidity: Some pooled investments are more liquid than others, so make sure you know the rules before you dive in. The last thing you want is to have a significant portion of your assets tied up when you need to access them.
Ponzi Schemes: For the uninitiated, a Ponzi scheme is a type of investment fraud that pays returns to existing investors using funds contributed by new investors. These schemes collapse when the flow of new money isn’t enough to satisfy old investors, or too many investors want to cash out early.
Detecting a Ponzi scheme isn’t always easy. It’s not uncommon for fund managers to promise higher than average market returns, often boasting figures ranging from 10% to 35% or higher. You might see performance reports saying they’ve never had a losing quarter.
Those factors could be red flags that warrant further investigation. Still, any investment opportunity that is “guaranteed” or has no fluctuations in returns are classic warning signs. If you fall prey to a Ponzi scheme, you are likely to lose a significant portion of your investment, if not the whole thing.
Every year, dozens of Ponzi schemes are reported, with total combined losses topping between $1.5 and $2 billion annually.
Incompetence: As if looking for crooks wasn’t difficult enough, you could also encounter fund managers that are grossly incompetent. This is harder to detect, and not necessarily illegal. Incompetence could include everything from making poor investment decisions to using management fees for expensive dinners and vacations.
Management Fees: Okay, so even if you found the most honest, talented fund manager on the planet, you’re still going to paying a substantial amount of fees.
The type and amount of fees will vary by the type of fund, but could include a percentage of your investment, transaction fees, finding fees, and deal managing fees.
Despite the potential pitfalls, there are some very real pros to pooled investments.
Diversification: A pooled investment allows you to own multiple asset classes or sectors in a single vehicle, eliminating the need for you to research and secure a wide array of investments. This type of investment spreads out the risk, so if one piece of the portfolio flounders, you’ll have others to fall back on.
Convenience: Instead of investing in individual stocks or a single piece of real estate, you can own multiple assets in a single transaction.
Flexibility: If you’re investing retirement funds, keep in mind that many employer-sponsored retirement plans don’t allow for individual stocks. However, you could potentially use your retirement fund for a mutual fund or an ETF.
Opportunity: Pooled investments can open the door to opportunities reserved for only large-scale or institutional investors. Further, let’s say you want to start investing in real estate. You might not have the funds to buy 10 properties in different geographic markets, but a pooled investment will allow you to do exactly that.
Cost: If you want to purchase multiple stocks, you could be subject to substantial commission fees from frequent trading. Those fees could diminish your returns.
The Bottom Line: As with any investment, the most important factor is to do your research. Ensure you are dealing with a reputable firm and individual. It’s also vital that you understand the asset class you’re investing in. You don’t necessarily have to be an expert, but you should be familiar with the stocks in a fund or the properties in a REIT.
If you’re trusting a fund manager, do some due diligence about the person before writing a check or wiring money. Look for any disciplinary reports filed against brokers by searching the Financial Industry Regulatory Authority (FINRA). And, of course, read any documents and contracts thoroughly. It’s a common mistake to assume that they’re boilerplate and include nothing notable, but you’d be surprised at what you find if you examine them with a fine-tooth comb.
Despite the warnings (which you should definitely heed), pooled investments can represent an opportunity to explore an asset class without having a large stake. If you’re new to pooled investments, consider dipping your toe in the water before diving in headfirst.
