If the recent economic rollercoaster has taught us anything, it is that we should understand what we’re investing in before we make that investment. And, if we are trusting other people with our money, we should know what they are doing with it.
One of the chief villains in the financial meltdown appears to be derivatives. Warren Buffett even called them “financial weapons of mass destruction.” So, what are derivatives, and why can they be such a problem? I’m going with Jaceson Maughan’s definition: “A derivative is essentially a binding contract for a person to buy or sell an asset at some point in the future, but the person is paying for it in the present.” Jaceson uses a great example with rice farmers that illustrates the process and shows why derivatives can be risky—because the buyer can’t predict whether or not there will be more or less of the asset. Everything depends on the asset itself.
The point is that no one can predict what is going to happen in the market. All investments carry risk, and some carry more risk than others. For that reason, you need to ask questions of your financial planner or your HR rep to find out where your money is going. And, if you don’t understand how it works, don’t give them your money. Check out Life123’s stock market terms for even more information so you can ask even better questions of those who handle your cash.
Tags: derivatives, Money, stock market
