High-risk investments to avoid in 2022

In 2022, the Standard & Poor's 500 index recorded its worst start in 50 years. Although the index has recently recovered from 52-week lows, the economy is increasingly threatened by recession. Meanwhile, the Federal Reserve has shown that it will go to great lengths to keep inflation in check, which, according to many market observers, means the economy is almost certainly headed for the abyss.

The country's central bank has rushed to raise interest rates, putting a strain on the overheating economy. Investors are assessing the situation and trying to position themselves, which has led to a flurry of stock and bond purchases. However, while short-term rates have risen, the benchmark 10-year bond has not touched its highs as investors begin to think about a recession.

The 5 riskiest investments of the moment

How can investors protect their portfolios until the end of 2022? One of the main ways is to avoid the riskiest investments, those that might not emerge unscathed from a recession.

1. Cryptocurrencies

Cryptocurrencies are a type of digital currency that has been attracting investors' interest for about five years. However, they are one of the riskiest investments because they are generally not backed by the assets or cash flows of an underlying entity. Cryptocurrency traders are therefore trying to get ahead of the curve by choosing the most promising digital tokens.

Legendary investor Warren Buffett has come out strongly against cryptocurrencies. Speaking at his company Berkshire Hathaway's annual meeting in April 2022, Buffett said, "I don't know whether cryptocurrencies will go up or down next year, or five or 10 years from now. But what I'm pretty sure of is that they don't produce anything..... To have value, assets have to do something for someone.

Ultimately, the only thing that sustains cryptocurrencies is investor sentiment, which can run out at any time. In August 2022, bitcoin and ethereum were already more than 60 percent below their all-time highs.

2. Consumer discretionary securities

Unlike Buffett's perennial favorite consumer goods, whose products are bought almost regardless of economic trends, the performance of consumer discretionary companies can be more volatile. Consumer discretionary companies are often much more dependent on the overall health of the economy than commodities, which means that demand for discretionary products fluctuates more during economic downturns.

While some discretionary activities may have relatively stable sales, most others fluctuate much more. For example, hotels, restaurants and leisure are popular sectors when the economy is growing, but sales decline rapidly when times get tougher and consumers reduce spending.

Therefore, if the economy slows down, consumer discretionary goods may be a sector to avoid in 2022.

3. High-yield bonds

High-yield bonds, once known as "junk bonds," vary widely in quality. Debt can be issued by excellent companies or by frankly mediocre companies. Therefore, if you invest in individual bonds, you must examine each company to determine whether it is of high quality or not.

When the economy enters a recession, investors demand a higher potential return from the worst-performing companies and then lower the price of their bonds to compensate. Although high-yield bonds are generally expected to fall in a recession, many of the worst-performing bonds will remain down.

If you buy an ETF or mutual fund, it is best to avoid high-yield bond funds. Although diversification can probably protect you from some of the hardest hits, it will not protect you from the general decline that can hit high-yield bonds when investors get spooked.

4. Stocks of highly leveraged companies

Highly leveraged companies can be dangerous investments at any time. But in a downturn they can be deadly. These companies spent the boom accumulating debt or defaulting. During an economic downturn, companies are often hit by declining sales, which can make it even more difficult to repay debts. In addition, all this debt prevents companies from taking the desperate measures they may need to survive.

The most fragile and indebted firms are likely doomed, and rightly so. Some will fail, but those that emerge on the other side of the crisis can produce spectacular returns because investors decide that the company is not ready to die. The title then changes from "doomed company" to "company at a steep discount to its competitors," but this change is at your own risk!

5. Cyclical industrial companies

Like consumer discretionary companies, cyclical industrial companies can also be affected by boom and bust economic cycles. When times are good, it seems like they can't get any better. And when times are bad, it seems they cannot get worse. Their stocks reflect this duality, with rapid appreciation in good times and an equally rapid decline in bad times.

What is particularly tricky about cyclical industrial companies is that they can appear to be the cheapest at the very time when it is most dangerous to invest in them. Based on valuation measures such as price-to-earnings (P/E) ratios, they seduce investors with the siren song of low multiples (seven to ten times earnings) when they are near their peak. However, when they are at their lows, during or after a recession, they appear very expensive, trading at multiples of 40 or 50 times earnings, assuming they are generating profits.

That said, if you know what you are doing, you can make a killing when the market turns after a recession.

Conclusion

Investing in individual stocks is a difficult game to win because it requires a lot of time and energy. You can do as well or better by following Warren Buffett's classic advice. The Oracle of Omaha has long advised investors to buy and hold an index fund based on the S&P 500 index, which yields about 10 percent a year for long periods. Although it too may decline in the event of an economic downturn, this fund has a diversified portfolio of the best U.S. companies, which means it is likely to rise as soon as the economy recovers.

Editorial warning: all investors are advised to do independent research on investment strategies before making any decisions about them. In addition, investors are cautioned that past performance of investment products does not guarantee future price appreciation.