Topic: How To Invest

Investor Toolkit: What every investor must know about investing money in futures

Every Wednesday, we publish our “Investor Toolkit” series on TSI Network. Whether you’re a new or experienced investor, these weekly updates are designed to give you specific advice on successfully investing money. Each Investor Toolkit update gives you a fundamental tip and shows you how you can put it into practice right away.

Tip of the week: “Investing money in futures gives you high leverage, but leverage works two ways.”

Futures trading provides a perfectly legal way to bet on price changes in commodity, currency and financial markets. When you buy or sell a futures contract, you commit yourself to buy or sell a quantity of a commodity (or currency or financial instrument) in the future. The date and quantity are standard; you fix the price when you buy or sell the contract.

Here’s an example: Say you buy a March wheat contract at $7.14. That means you’ve agreed to a contract for 5,000 bushels of wheat in March, paying $7.14 each, for a total of $35,700. The seller has agreed to sell that much wheat at that price on that date.

Since the transaction takes place in the future, the buyer and seller only put up a deposit of, say, 5% of the $35,700. This provides enormous leverage. A 5% price rise represents a 100% gain for the buyer and a 100% loss for the seller.

Futures started out as a convenience for commercial interests. Farmers sell wheat futures to fix their income from this year’s harvest. Bakers buy wheat futures to fix their flour costs. But most futures transactions take place between speculators who are simply betting that prices will rise or fall. Most contracts get closed out prior to delivery.


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Futures are different from investing money in stocks and mutual funds

  • Futures contracts have a fixed life, usually under one year. You can hold stocks or mutual funds indefinitely.
  • Futures contracts don’t provide income. By investing money in stocks (and funds that invest in them) you can receive dividend payments.
  • Futures are a speculation — a bet on price movements. To make money, you have to outguess other players by a wide enough margin to pay commissions. Stocks and funds are an investment because they let you profit from economic growth.

Our investment advice: In theory, high leverage makes it possible to turn a modest stake into a fortune in futures. In practice, most futures speculators wind up losing money. Successful investors recognize that investing money in futures is a form of recreation. You do it for fun, not profit.

Next Wednesday, December 15, 2010, Investor Toolkit will look at where your home should fit in your investment strategy.

If you want to invest aggressively, you are far better off to avoid futures and instead buy aggressive stocks, such as those we recommend in our Stock Pickers Digest newsletter.

The latest Stock Pickers Digest gives you our full analysis, including clear buy/sell/hold advice, on 18 stocks that may be suitable for the part of your portfolio you devote to aggressive investing. What’s, more you can get this issue absolutely free. Click here to learn how.

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