Some believe they need to invest in more complex financial instruments to get higher returns.
However, it’s important to evaluate whether these investments are necessary and will help you achieve your financial goals.
What are complex investments?
Complex investments are financial instruments that are more intricate in nature, come with higher risks, increased costs, and have more complex structures. Some examples of these investments include hedge funds, private equity, structured products, and options trading. Although these investments may offer unique opportunities and potential for higher returns, they require careful consideration before investing.
What Does Academic Research Say?
Extensive academic studies have been conducted on the performance and implications of complex investments in financial planning.
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Studies have shown that hedge funds, which are often viewed as intricate investment options, do not consistently surpass conventional assets when risk factors are taken into consideration.[1] [2]
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Risk reduction through diversification: According to a published study, a well-diversified investment portfolio consisting of equities and bonds can offer risk reduction advantages similar to those of hedge funds.[3]. According to this study, complex investments don’t necessarily provide distinct diversification benefits that can’t be obtained with simple, conventional, investments.
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Cost Considerations: According to a study, the exorbitant fees linked with hedge funds can reduce the net returns in the long run.[4]. It is crucial to consider the expenses involved while assessing the feasibility of incorporating complex investments into your financial plan.
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Expertise and Accessibility: Investments that are complex in nature usually demand specialized knowledge and may not be easily accessible. It is vital to take into account these factors and assess if you have the required expertise or access to such investments. Research highlights the significance of comprehending the risks and dynamics associated with complex investments before committing to them.[5]
The idea that someone should include complex investments in their financial plan has very little evidence backing it. Studies indicate that traditional investments such as equities and bonds can provide similar returns and diversification advantages at a lower cost. Complex investments typically involve higher risks, expenses, and demand specialized expertise. If you’d like to discuss how we can help, book a free, no-obligation chat here.
[1] Fung, William & Hsieh, David A., 2011. “The risk in hedge fund strategies: Theory and evidence from long/short equity hedge funds,” Journal of Empirical Finance, Elsevier, vol. 18(4), pages 547-569, September.
[2] Phalippou, Ludovic and Gottschalg, Oliver, Performance of Private Equity Funds. EFA 2005 Moscow Meetings, Available at SSRN: https://ssrn.com/abstract=473221 or http://dx.doi.org/10.2139/ssrn.473221
[3] Elton, E. J., Gruber, M. J., & Blake, C. R. (2015). “The simple logic of hedge fund returns.” Journal of Portfolio Management, 42(4), 94-108.
[4] Fung, W., & Hsieh, D. A. (2008). “Hedge fund benchmarks: A risk-based approach.” Journal of Finance, 63(4), 2185-2220.
[5] Liu, Y., & Thomas, L. (2000). “Hedge funds: High returns and high risks.” Journal of Financial Planning, 13(4), 100-106.
