The North American Securities Administrators Association has released its annual list of top 10 investor traps, and it includes a rare offering from the mutual fund industry. Leveraged funds, which use futures and options to amplify returns, made their debut on NASAA's list, thanks to increasing public outcry about their volatility.
The funds try to return two to three times the daily returns — up and down — of a particular market index. For example, Direxion Daily Financial Bear 3X shares promise to rise or fall three times as much as the Russell 1000 financial services index. The fund fell 92% from March through May.
The funds mirror daily returns, not long-term performance, which can make them even more difficult to fathom. The Direxion Nasdaq-100 Bear 2.5X fund, for example, aims to gain 2.5 percentage points for every 1 percentage point the Nasdaq 100 loses in a day. But the fund fell 32.4% the 12 months ended July 31, according to Morningstar, even though the Nasdaq 100 fell 13.2%.
"If you want to gamble, go to Vegas — you'll have a better time," says Dan Calabria, author of Mutual Funds Today … Who's watching your money?
The Financial Industry Regulatory Authority and the Securities and Exchange Commission issued special alerts this week warning investors about the risks of leveraged funds.
The fund industry has been smacked by NASAA once before. State securities administrators chided funds for their role in the mutual fund late-trading scandal of 2004.
Other traps to avoid, according to NASAA:
•Natural resource investments. Whenever the price of oil and gas starts to soar, con artists trot out fake oil-well deals. "When oil was $100 a barrel, we had two or three dozen unregistered oil and gas deal cases," says Fred Joseph, Colorado Division of Securities commissioner.
•Gold and gold mining. Mark Twain once defined a gold mine as a hole in the ground with a liar standing in front of it. You should use a similar level of skepticism if someone pushes you to make a private investment in a gold mine. Be wary, too, of buying gold from an unknown dealer who also offers to hold the bullion for you.
•Real estate investment schemes. If you're in trouble with your mortgage, beware of con artists who offer to "fix" your mortgage for a fee, Joseph says. "Most of these advance-fee offers only generate a quick profit for the con artist and provide no benefit to the consumer."
•Entertainment investments. Want to earn big returns underwriting movies, infomercials, Internet gambling or pornography? You probably won't.
Further information about investment scams and how to avoid them can be found at www.nasaa.org.