Money Rehab with Nicole Lapin - You Can Invest in Next Year’s Orange Juice, Today. But Should You?

Episode Date: May 17, 2022

Today, Nicole explains futures contracts and what they have in common with Benjamin Button. See omnystudio.com/listener for privacy information.

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Well, it doesn't. Charge for wasting our time. I will take a check. Like an old school check. You recognize her from anchoring on CNN, CNBC, and Bloomberg. The only financial expert you don't need a dictionary to understand. Nicole Lappin. In the last year, we've tackled a range of investing topics.

We've talked about things that will be most helpful to folks who have never ever invested before, like index funds, and tips for more seasoned investors, like options. Today, we've got a question from an even more seasoned investor who wants to talk about the future. Hey, Nicole, my name is Will and I work in tech. I've really enjoyed listening to your podcast, especially the investing episodes. I'm looking to level up my investments. I've been investing in individual companies on Robinhood, and now I'm thinking of getting into some derivatives. Can you talk about futures contracts? What's the investment strategy there? Thank you so much for your question, Will. Let's dig into the future, shall we? So you know the expression, youth is wasted on the young? It's

typically a phrase used by older folks to articulate that the whole Benjamin Button aging backwards thing sounds pretty damn nice. That lucky duck Benjamin Button, you know, got all the wisdom of old age with all of that energy and physical ability of youth. In the saying, youth is wasted on the young, our elders are complaining that the youthful glow and bouncy step comes at the wrong time. And I think entrepreneurs feel this phrase deeply when it comes to money. When you're a business owner, the money comes at the wrong time. Say you're an aspiring farmer and want to have the biggest apple orchard so that you can make the best apple cider in all

the land. When the apple cider has been made and is ready to drink, that's when the farmer gets the money. But that's not when the farmer needs the money most, right? The farmer needs the money most for everything that comes before that point. Buying the orchard, the costs involved with taking care of the land, getting the equipment for making apple cider, whatever that equipment is. When it all comes down to it, the farmer needs the money that he or she will earn from the apple cider before the apple cider can actually be made. That's where futures contracts become super helpful. If you were an aspiring farmer and needed some cash for startup costs, you might come to me and say, hey, Nicole, are you interested in paying me five grand

now and in exchange you get all of my apple cider as soon as it's done? Well, maybe I have an idea for distributing said apple cider to a local grocery store. Or maybe I just really love apple cider. Either way, I say yes and we have ourselves a future contract. The lingo here is that the person who is paying the forward price, me in this example, is the person who goes long. And the person who shorts the contract is the one who is selling the asset. You, in this example. Futures help suppliers and manufacturers lock in prices so that random changes in circumstances don't totally screw them up. So returning to our example, a farmer might want a futures contract for the next year to ensure that no matter what

happens, they get a good market price for their crop. In essence, they're locking in a price to hedge against uncertainty. On the flip side, let's say a manufacturer makes canned soybeans and they want to make sure that they can count on a certain price for soybeans next year so that if that price goes higher, it doesn't screw up their business. The same thing goes for an airline company that needs to lock in the price for fuel for their operations. Like Will mentioned, futures contracts are a type of investment called derivatives. While stocks and bonds are very different assets, they have some general overlap.

With stocks and bonds, investors purchase the security and then they own it. The end. bonds, investors purchase the security and then they own it. The end. Derivatives play a whole different game because as the name suggests, they're not necessarily outright assets, but rather derivatives are the investment opportunities that derive from the value of another asset. And to complicate matters even further, derivative securities are often valued based on projections of future market trends. Because derivatives involve a lot of guesswork on how the underlying asset's value is going to change over time, derivatives are rife with speculation. In the world of everyday life, speculation might be used synonymously with gossip and rumor. Like, there's speculation,

she has a thing for the pool boy. In the financial world, the use isn't so different. Speculation is just a jargony term for a guess. The guesswork doesn't always pan out, and so derivatives can turn into debt very quickly. Speculation is a very loaded word in the world of finance because speculative investments have led to huge economic crashes, including the subprime mortgage crisis, the dot-com bubble, and so on. Therefore, derivatives are often an investment category that ends up being counted as a liability rather than an asset. Not all brokerages trade futures contracts. The ones that do really want to make sure an investor knows the risk of futures trading.

They also might have a minimum net worth or a minimum deposit required to get in the game. If the value of the contract goes down, you might get a margin call, which means you have to deposit even more money in the account to keep it open. For today's tip, you can take straight to the bank. Futures contracts are particularly challenging investments to get into right now because of just how many important factors are adding more uncertainty into our plans for the future. Take oil, for example. We have no idea whether COVID is going to intensify or ease up, and so it's hard to predict what travel trends are going to be ease up. And so it's hard to predict what travel

trends are going to be like. And therefore, it's hard to predict oil demand. We also don't know what the outcome of the Russia-Ukraine conflict is going to be and whether or not there will be more oil sanctions there, let's say. So even if you're a seasoned investor, a retail investor, so like you and me versus institutional investors like brokerages or hedge funds, I would really recommend staying away from futures contracts until there are fewer unknowns, at least around the bend. Money Rehab is a production of iHeartRadio. I'm your host, Nicole Lappin. Our producers are Morgan Lavoie and Mike Coscarelli. Executive producers are Nikki Etor and Will Pearson. Our mascots are Penny and Mimsy.

Huge thanks to OG Money Rehab team Michelle Lanz for her development work, Catherine Law for her production and writing magic, and Brandon Dickert for his editing, engineering, and sound design. And as always, thanks to you for finally investing in yourself so that you can get it together and get it all.