RETIRED HEDGE FUND manager Jim Cramer is the host of Mad Money, a staple of financial television. For years, critics have derided his investment recommendations—to the point where there’s now a fund designed specifically to bet against him: the Inverse Cramer Tracker exchange-traded fund (symbol: SJIM).
For investors who see Cramer as the P.T. Barnum of finance, this fund offers the ability to make bets that are precisely the opposite of what Cramer recommends. “We watch Mad Money so you don’t have to,” reads the fund’s website. “Find out what Jim likes so you can sell it, and what he doesn’t like so you can buy it.”
While colorful, the Cramer fund is just one of more than 500 new exchange-traded funds (ETFs) introduced last year. Investors in the U.S. now have more than 3,500 ETFs to choose from. Among them: COW to invest in agriculture and KARS to bet on electric vehicles. The latest development: The SEC recently approved 11 new bitcoin-tracking ETFs.
With thousands of options, you may be wondering how to make sense of the investment universe. Which funds are worth considering? To help answer this, I would start with this basic principle: Every investment can be evaluated through three simple lenses. In order of importance, they are:
Since risk is first on this list, that—I think—is the easiest way to decide if an investment is worth your time. How can you assess risk? While every investment is different, most can be plotted somewhere on the spectrum outlined below—going in order from most risky to least:
Alternatives. In the world of investments, stocks, bonds, cash and real estate represent the basic building blocks. But there are many alternatives, including gold, commodities, managed futures and cryptocurrencies, all of which are available in the form of exchange-traded funds. Some ETFs are even set up to mimic hedge funds and other strategies typically found only in private funds.
These alternatives carry above-average risk, in my view. Why? In most cases, the underlying investment is one that lacks intrinsic value, meaning the investment doesn’t produce income in the way that stocks produce dividends or bonds produce interest. That poses a risk because it means there’s no logical basis for valuing these assets, and thus there’s no floor to support their prices.
That, for instance, is why the price of bitcoin is so volatile. Unlike a stock or a bond, there’s no fundamental basis for determining the “right” price for bitcoin. That makes cryptocurrencies and other alternatives among the riskiest investments out there.
Leveraged single stocks. Stocks generally do have intrinsic value, and that makes them inherently less risky than alternative asset classes. But any individual stock still carries risk simply because adverse events can affect any one company. Unfortunately, Wall Street has found a way to amplify this risk.
Suppose you like Tesla. You could buy the stock, but if you wanted to dial up the risk in your portfolio, you could buy a fund like GraniteShares 2x Long TSLA Daily ETF (TSLR). This fund uses leverage to promise investors 200% of the daily performance of Tesla’s shares. If Tesla’s stock gains 5%, this fund should rise 10%. If, on the other hand, you have a negative view of Tesla, GraniteShares offers a fund (TSDD) that promises 200% of the inverse performance of Tesla’s stock.
Some funds take this a step further, using leverage to bet on alternative investments. That’s what the 2x Bitcoin Strategy ETF (BITX) does. This is very far out on the risk spectrum.
Leveraged index exposure. Using leverage to bet on a single stock is very risky. Lower down the risk ladder are funds that use leverage to bet on the entire market. A fund like Direxion Daily S&P 500 Bull 3X Shares (SPXL) is designed to give investors 300% of the daily return of the S&P 500-index. Last year, when the S&P 500 rose 26%, this fund soared 69%.
The fund’s cousin, the Direxion Daily S&P 500 Bear 3X Shares (SPXS), is designed to do the opposite: It provides 300% of the inverse of the S&P 500’s daily return. Last year, it declined by 46%.
Narrow indexes. Investment commentators—myself included—spend a lot of time talking about the differences between actively managed funds and index funds. The reality, though, is that there are thousands of index funds, and some are much riskier than others.
If you’re evaluating an index fund, make sure it isn’t limited to a narrow corner of the market. Very common, for example, are funds that hold stocks in just one sector—technology, for example. That can be risky because stocks in a given industry tend to rise and fall together. Instead, look for a broadly diversified fund, such as one that includes the entire S&P 500-index of large-cap stocks, or one that covers the entire U.S. market.
Actively managed funds. Why do actively managed funds have so many detractors? The problem is that they rely on human judgment, and no one can see the future. That’s why—counterintuitive as it may seem—index funds, which have no real manager, have beaten the performance of funds run by well-informed, hard-working and highly compensated managers.
To be sure, some actively managed funds do outperform each year, so it’s important to look at industry-wide data. Actively managed funds, on average, tend to underperform index funds while generating larger annual tax bills.
Broad-market index funds. How can you avoid all the risks outlined above? The ideal investment, in my opinion, is a simple, broadly diversified stock or bond index fund, such as one that tracks the S&P 500. While no investment is without risk, my view is that funds like this carry the least risk. That’s because stocks and bonds have intrinsic value, there’s no leverage amplifying the risk, the fees are low, they’re tax-efficient and there’s no risk of misjudgment by an active manager.
Postscript: It turns out Jim Cramer may have had the last laugh. Last week, the manager of the Inverse Cramer ETF, which was launched just last year, announced that it’s shuttering the fund.