High-risk investment funds can be mutual funds or private investment companies such as hedge funds, which allow certain investors the opportunity for very high returns. Understanding the risks and types of these investments is critical to ensuring unintended risk is not taken.
Hedge funds are not registered with the Securities and Exchange Commission (SEC) the way mutual funds are and so are available only a few investors per fund. That means that the minimum investment set by the hedge fund is sometimes $1 million or more. The attractiveness to wealthy investors is that investment techniques and investments not allowed in mutual funds, such as derivatives and short selling, are permitted in hedge funds. They carry special risks due to the exotic nature of the investments and the difficulty in understanding the investment strategy and methodology.
Private placements are stock offerings that do not entail an initial public offering (IPO). The shares are sold directly to a select group of private investors, pension funds or other institutional investors. Private placements carry risks because the prices are not determined through an open market process such as with an IPO. Therefore, understanding the value of the investment is somewhat more difficult.
Emerging market investments are those in developing nations or economies. In previous years, the BRIC countries (Brazil, Russia, India and China) came to represent rapidly developing economics with numerous high risk/reward investment opportunities. The investment opportunities that are most easily accessible to common investors are exchange-traded funds (ETFs) and mutual funds that invest in those counties specifically. There are several emerging market ETFs and mutual funds.
High-yield investments are bonds that are below investment grade, called junk bonds. Investment grade bonds are rated BBB or better. Junk bonds are attractive because the issuing firm is required to pay a much higher yield than a company with a stable outlook. For example, if Microsoft issues a bond, it will pay a much lower interest rate than will a company on the brink of bankruptcy. The benefit to the investor is that as long as the company doesn't go bankrupt, it will earn significantly higher income.
High-risk investments should be considered carefully and entail numerous risks. They should represent only a small part of a portfolio for the vast majority of investors. Age, risk tolerance and financial needs are all important considerations in determining if these investments are right for you.