Nondiversifiable Risk

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Definition / Meaning of

Synthetic Investment

Categories: Finance,

A synthetic investment simulates the return of an actual investment, but the return is actually created by using a combination of financial instruments, such as options contracts or an equity index and debt securities, rather than a single conventional investment. For example, an investment firm might create a synthetic index that seeks to outperform a particular index by purchasing options contracts rather than the equities the actual index owns, and using the money it saves to buy cash equivalents or other debt securities to enhance its return on the derivatives. Options spreads, structured products, and certain investments in real estate and guaranteed investment contracts can be described as synthetic products. While they are artificial, they can play a legitimate role in an individual or institutional investor's portfolio as a way to reduce risk, increase diversification, enjoy a stronger return, or meet needs that conventional investments don't satisfy. However, synthetic investments may carry added fees and add more complexity than you are comfortable dealing with.