Beware of New Products
Wall Street continually develops new financial products. Investors should be wary. The products can be expensive roach motels: easy to buy, hard to sell. New products are sometimes sold to unsuspecting investors because institutional investors are trying to unload difficult positions. One top municipal bond dealer introduced several ETFs during the worst of the credit crisis when no one wanted to buy municipal bonds. The ETFs let the dealers sell positions to unsophisticated investors that sophisticated investors would not touch. Remember that story when considering buying a new financial product. Find out why the product is being sold and who is behind the effort. If you understand the motivation behind the product, you better understand the risk.
A key risk, at least initially, to all new products is that they typically have little liquidity. Many seasoned investors avoid new products for at least six months, or until the new product has average daily trading volume of at least 1 million shares, or some other volume level that indicates the securities can be bought and sold without impacting the price. Liquidity simply means that there are buyers and sellers. Look at IBM’s stock. It trades millions of shares each day. You can buy and sell IBM stock without any problem. An order to buy or sell 100 shares, or 10,000 shares, will not change the price. It’s the opposite with many new financial products. They are often easy to buy and hard to sell.