'Safe' investments that are actually risky

(Money magazine) -- This is the fourth part of Money magazine's series on How to make your money safer.

In jittery times, count on the financial services industry to wheel out products that play to your fears. Such investments are often marketed as low risk, but that safety is often oversold or too expensive.

The pitch: These funds use shorting -- selling borrowed shares in hopes of profiting if stocks drop -- and options contracts to ensure that when the market sinks, your returns will soar.

The reality: Even when the market isn't plummeting -- and that's most of the time -- these funds keep shorting. Over the past three years, bear funds lost 28% a year on average, vs. the S&P's 19% gain.

The pitch: We'll give you hedge-fund-like performance -- low risk with steady returns, regardless of whether stocks go up or down.

The reality: Because these funds typically rely on complex strategies, including options, short-selling, and derivatives, costs average a steep 2%.

Not surprisingly, returns have been disappointing.

One type, known as "absolute return" funds, promises to beat set goals. Putnam's Absolute Return 700 fund (PDMAX), for instance, seeks to outpace T-bills by seven percentage points over three years. It wound up outperforming by eight. In the past year, though, it's short by five points.

The pitch: Why settle for sub-2% yields on 10-year Treasuries when high dividend payers are giving 4% or more?

The reality: Stocks are not bonds. They're a lot riskier -- in 2008 the S&P sank 37%, while the average taxable bond fund fell just 5%.

And stocks with the highest yields tend to be in the biggest financial trouble. Their yields may be high because investors are taking a sledge hammer to the prices, not because payouts are rising.

The pitch: Earn the returns of stocks with no risk of losing money, thanks to the underlying insurance on your investment. Your money will also grow tax-deferred, and you can convert to an annuity later on.

The reality: These are complex policies that don't deliver what you might expect.

Instead of mirroring a stock market index, the annuity's returns are capped -- recently many policies limited gains to 3.5% annually (the specific cap can change).

Worse, those returns don't include dividends, which have historically accounted for the bulk of the market's long-term returns.

Index annuities also incur high costs. And unless you hold for 10 years or more, you'll have to pay steep surrender charges to sell -- as much as 20% to start.

More ways to Make your money safer:

How to pick stocks without being burned

7 low-risk funds for the long haul

Fixed income: 4 safer bets for today's market