Other Real Estate And Adjacencies
As expansive as CRE is, it is not all there is to the market.
First of all, there is opportunity in residential real estate — buildings with living space for between one and four households. In much the same way people might buy their own house, they can buy another and rent it out. If they are handy and are good project managers, they can participate in the “fix-and-flip” market — buying substandard homes, improving them, and reselling them at a much higher price.
Farms represent another set of opportunities. Few people involved in alternative investments want to work the farm, but it could be a lucrative hobby with the right tenants in place to do so. While one generally thinks of dairy or poultry or grain farms, the CNN article notes how investors have succeeded in raising habañero peppers, organic sprouts, or Christmas trees.
In some sections of the U.S., particularly out West, water and mineral rights trade separately from the existing topsoil and buildings. Like collectibles, they trade at an auction or via private sale. Both private auction houses and state governments conduct auctions.
Do You Need Alternative Investments
The key to investing is diversification.
You dont want to be overexposed in any one area.
Its why experts recommend you get an appropriate mix of stocks and bonds. Its also why you need a good mix of domestic and international, so the woes of any one nation dont sink your fortunes. Its also why experts recommend some part of your portfolio to be in alternative investments.
In theory, alternatives arent supposed to be strongly correlated with the stock market or many external forces. They may be negatively correlated, as often is the case with gold and the stock market.
Alternative investments are often used as a hedge against the rest of your portfolio.
We reached out to Professor Kevin R. Mirabile, a Clinical Associate Professor of Finance at Fordham University, to get his thoughts on the role of alternative investments in a portfolio. He is the Director of the Alternative Investment Program at the Gabelli School of Business and well suited to give us his thoughts on alternative investments:
Alternative Assets: Investing Beyond Stocks Bonds And Cash
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Alternative may bring to mind renewable energy or a mixtape from the 1990s, but it has a place in the investing world, too, referring to just about any asset that is not stocks, bonds or cash.
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What Makes Alternative Investments Different
Alternative investments are different for a host of reasons. Unlike traditional investments, alternative investments arent traded on public stock markets. You wont be able to ascertain the value of an alternative investment like you could with a stock price, as these investments arent listed on exchanges.
Rather, you would reach out to the individual who manages the investment opportunityfor example, the portfolio manager at a hedge fundfor this information.
Alternative investments have a different relationship with the markets than their conventional counterparts. According to the CFA Institute, these investments may perform well even when the overall market is bullish, or vice versa.
For example, private equity has outperformed public equity in U.S. state pensions for 15 years, to the tune of 489 basis points higher than the S& P 500 index. This is one of several reasons why alternative investments can help round out a portfolio and hedge against market losses.
What Defines An Alternative Investment
Because the term is so all-encompassing, it’s often easier to define alternative assets by what they’re not rather than what they are.
The group includes any asset that doesn’t fit into one of the conventional categories, known as traditional investments, touched on above: cash, stocks, and bonds, as well as the mutual or exchange-traded funds that hold them.
It could be a physical item like a valuable bottle of wine, a piece of art, or an office building. Or something more intangible, like a derivative or an ownership stake in a private business.
What alternative investments all have in common, however, and in contrast with traditional investments, is that most of them aren’t regulated by the United States Securities and Exchange Commission .
Whereas traditional investments are governed by strict disclosure regulations and protections against fraud, alternative investments put the onus on the investor. If you purchase a piece of art, for example, and then determine that it’s a forgery but can’t track down the seller, that loss is yours to swallow.
For those reasons, as well as the high investment minimums that often accompany them, alternative investments have traditionally been most popular among investors with extensive capital and income, plus experience in dealing with complex financial assets.
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Our View On Alternative Investments
You have likely heard of a 60/40 portfolio a portfolio that is composed of 60% stocks and 40% bonds. One rationale for the 60/40 portfolio has long been that stocks and bonds are negatively correlated. In simple language, the belief has been that when stocks lose their value, bonds should hold their ground or even appreciate in value, helping stabilize the portfolio during periods of market unrest.
This year has been another proof point that this assumption is flawed.
Year-to-date, the U.S stock market is down 20% while the bond market is off roughly 10%. This means that even the most conservative of traditional investors with an asset allocation of 10% stocks and 90% bonds is down double digits in 2022. And while this investor has done very well over the last decade, there is no way around it: the volatility in the public markets this year is uncomfortable, especially so because the stock and bond markets have moved lower in tandem.
So, what is an investor to do?
One solution is to look beyond a traditional mix of stock and bonds when building a diversified portfolio. Specifically, exploring alternative investments that are 1) less interest-rate sensitive than bonds and 2) insulated from some of the volatility found in the public equity markets. This perspective is not new to our team. Alternative investments have been a part of our firms DNA from the beginning, and we have been helping clients navigate alternatives, when appropriate, since 2008.
Why Asset Allocation Is Important
There is no simple formula that can find the right asset allocation for every individual. However, the consensus among most financial professionals is that asset allocation is one of the most important decisions that investors make. In other words, the selection of individual securities is secondary to the way that assets are allocated in stocks, bonds, and cash and equivalents, which will be the principal determinants of your investment results.
Strategic Asset Allocation to Rebalance Portfolios
Investors may use different asset allocations for different objectives. Someone who is saving for a new car in the next year, for example, might invest their car savings fund in a very conservative mix of cash, certificates of deposit , and short-term bonds. An individual who is saving for retirement that may be decades away typically invests the majority of their individual retirement account in stocks, since they have a lot of time to ride out the marketâs short-term fluctuations. Risk tolerance plays a key factor as well. Someone who is uncomfortable investing in stocks may put their money in a more conservative allocation despite a long-term investment horizon.
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Myth: Only Institutional And Ultra
Reality: Individual investors have greater access to alternatives than ever before due to innovations in product structures. Open-end mutual funds, for example, have no-or-low barriers to investing. Other structures, such as registered closed-end funds and unregistered funds, have some limits on who can access them.
There’s More To Investing Than Just Stocks And Bonds
Alternative investments frequently surface as options for investors who are looking for ways to change their volatility exposure and potentially generate additional returns beyond holding stocks and bonds. For the right investor, alternative investments can be a compelling choice for a diversified portfolio.
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Risks Of Alternative Investments
- Lack of regulation. Not all alternative assets are registered with the SEC, and therefore are not regulated. However, they do fall under the purview of the Dodd-Frank Act and therefore their practices may be reviewed by the SEC.
- Lack of transparency. Since most alternatives are not regulated by the SEC, there are few to no public regulatory filings. This results in a dearth of information for investors.
- Low liquidity. Because many alternatives are not publicly traded, it may be difficult to buy or sell these investments. Many hedge funds and private equity funds may have lockups that commit investors to a defined period of investment during which redemptions are not possible.
- Difficult to value. In the absence of a market price, it may be challenging to determine the value of alternative investments. Valuations may vary widely depending upon the appraiser and are more vulnerable to subjectivity.
- High minimum investments. Alternatives are not structured with the average investor in mind, so minimum investment requirements can be prohibitively high.
- Greater risks. With the potential for high returns comes higher risk. Many alternative investments may involve risky strategies like short selling or trading complex derivatives.
Startups & Privately Held Companies
If you want to invest in a startup, there arent very many options out there. If you want in at the Friends & Family round , chances are you have to be friends or family with founders and that requires a fair amount of intentional networking. Its certainly an alternative investment but a very risky one youre often betting on the person rather than the business. Even then, things can go badly very easily.
If you want to invest in startups further down the road, there are several options. The most well known is going through a platform like AngelList and their AngelList Syndicates platform. Many of the really good ones are invite only but within those there are ones with fairly flexible invitation polities .
Alternatively, you can go later stage through with a platform like Linqto. If youre an accredited investor, you can use Linqto acquire shares in privately held companies with a minimum of just $10,000.
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Direct Investment In Start
Youve probably heard stories about a guy who gave Jeff Bezos 300 bucks in 1994 and now owns a continent. Or a grandma who invested all her savings into Theranos and now lives in her Buick. Startups are either home runs or theyre strikeouts, New York based securities lawyer Gregory Sichenzia told U.S. News recently, so anyone investing in them should be aware that they run the risk of losing every cent they invest.
Thanks to a 2012 law that loosened the restrictions on crowdfunding for startups, investing in private companies is easier than its ever been and available to basically any level investor. Risks and rewards will generally be commensurate with the investment stage you invest in: those who invest in the seed round of a company will more likely lose their entire investment than someone investing in a company in its late stage round. Vetting startups is no small task, so companies like SeedInvest have entered the fray promising that they will help small investors find startup opportunities with companies that have had their tires thoroughly kicked.
The downside of any kind of investment in a startup is in most cases, your money will be tied up until the company is acquired or goes public. One way of gaining exposure to the potential upsides of startups while not going all in on one specific company is to invest in one or more publicly traded venture capital firms.
What Investments Can Be Held In An Ira
Almost none of the aforementioned asset types, as of this writing, are permitted in any 401 account or most other qualified plans, including most individual retirement accounts. The one exception is the self-directed IRA, as we have covered previously.
And yet, for all the risk these alternative investments pose in isolation, they might be spectacularly accretive as elements in a diverse, well-balanced portfolio.
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Investing Goals & Risk Tolerance
One of the most important considerations when picking a bond alternative is your overall goal. Are you mostly looking for fixed-income and as low risk as possible? Or do you value growth more and are willing to stomach a bit of volatility and risk?
Start by outlining your investing goals in terms of the returns you’re looking for. Next, think about your overall risk tolerance and what’s acceptable to you. Usually, knowing these two factors will point you in the right direction for how to build your portfolio.
What Is Asset Allocation And How Can It Impact Your Investment Portfolio
Your asset allocation can have a significant impact on your investment portfolio. But what is asset allocation? And how can you best take advantage of it within your portfolio? Read on to find out everything you need to know to get the most out of your asset allocation to accelerate the achievement of your financial goals.
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How Much Should You Invest In Alternative Investments
The amount you should consider funneling into alternative investments will vary. There isnt a one-size-fits-all number to target.
However, most experts agree to keep it fairly low. Some financial advisors recommend that alternative investments make up 7% to 12% of your total portfolio. Others may suggest a range of 10% to 30%.
Due to the added level of risk and lack of liquidity, alternative assets shouldnt be your primary source of investment income. But, you should also make sure your entire nest egg isnt wrapped up in an employer-sponsored plan.
Ultimately, the amount you invest in an alternative investment should depend on your risk tolerance and retirement timeline.
No Daily Price Movement
Since alternative investments are removed from daily market movements, their value can either increase or decrease independently from whats happening on the stock exchange. If youre someone who doesnt like the stress of daily price fluctuations, alternative investments may be more appealing.
In fact, its not uncommon for many alternatives to increase in value in spite of economic factors that weigh down the markets. Having investments that dont ebb and flow with Wall Street can help create a more robust and diversified portfolio.
For example, real estate investments tend to increase in value during inflationary periods, as rent and value increases. Commodities, such as corn and livestock, also tend to rise in value with inflation, as these goods end up selling for more money than they would when currency values are stable.
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What To Be Wary Of
Most investors will never seriously trade in alternative investments, and thats OK alts are often risky and lightly regulated, if at all. That means it can be hard to get transparency on pricing, that is, to know whether this asset is really worth what youre paying or getting paid. Alts also are more illiquid, meaning they are more difficult to turn back into cash. Selling $1,000 in shares of a publicly traded stock is relatively easy pricing and selling a $1,000 rare coin or record album, less so.
So caution is required: Financial advisors recommend that alternative investments make up no more than a 10% slice of any portfolio, according to a 2016 survey co-sponsored by the Financial Planning Association.
These Portfolio Diversifiers Aren’t Just For The Wealthy
It’s not only music lovers who venture beyond the mainstream to tune in to alternative offerings. Main Street investors in search of diversifiers, shock absorbers and risk reducers for their portfolios should also consider owning a small sliver of alternative investments, or ones that differ from plain-vanilla asset classes such as stocks, bonds and cash.
Access to “alt” investments, such as hedge funds, private equity, venture capital and the like, is still restricted mainly to “accredited” investors, or wealthy investors who meet Securities and Exchange Commission requirements, such as having a net worth of more than $1 million or annual income of more than $200,000 .
Alternative offerings available to accredited investors face less regulatory scrutiny . They also tend to include private companies and asset classes that don’t trade on public exchanges and employ more-sophisticated strategies.
For instance, private equity refers to investments in companies that aren’t publicly traded. Hedge funds can use borrowed money to amplify returns, and they can sell stocks short, betting on a price decline, which gives them the ability to make money in down markets. Alternative investments are less liquid, which means theyre harder to buy and sell quickly. And they typically require a longer holding period to realize profits.
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Are Alternative Investments Safe
Although they are not bound by the same rules doesnt mean that alternative investments are the wild west of the investment landscape.
Its a business transaction, and if someone who is trying to attract alternative investors is purposely keeping them in the dark or being deceitful about an asset, they are unlikely to go too far. But it does mean that a novice investor might not be equipped to invest in alternatives.
These investments are typically open only to a specific class of investors . These investors understand the alternative investment assets, associate risks, return potential, and typically have enough funds to cover a sizeable part of alternative investments.
The value of these investments cannot be shredded into tiny little pieces and sold in the market . Limiting the number of investors is beneficial for both everyone: Neither the asset value nor the returns are diluted.
Another distinction is that alternative investments do not necessarily follow the current market trends and help you make money even when the stock market cant.
Alternative investments include hedge funds, derivative contracts, cryptocurrencies, commodities, collectibles, and ironically, real estate. Ironic because real estate investing is centuries older than stock exchanges.