Alternative Investing 101: Are You Truly Diversified?

December 13, 2020

Stocks are up. What could go wrong?

Plenty of things, in fact.

Equities can be great during periods of economic growth, returning multiple times their original value, but can give up much of that value during times of pullback. Bonds, on the other hand, don’t grow as quickly as stocks but can offer investors a measure of downside protection since they continue to pay reliably even during a recession.  

For investors, diversification matters. But there’s more to a well-diversified portfolio these days than just those two well-known options.

In fact, alternative investments are becoming increasingly important as tools for everyday investors to grow their investment returns while simultaneously protecting their portfolios.

According to Blackrock, alternatives are “investments in assets other than stocks, bonds and cash, or investments using strategies that go beyond traditional methods, such as long/short or arbitrage strategies. Since alternatives tend to behave differently than typical stock and bond investments, adding them to a portfolio may provide broader diversification, reduce risk and enhance returns.”

Over the past 20 years, alternative investments have, on the whole, outperformed more traditional asset classes like stocks and bonds. In fact, since 1998, real estate alone has returned more than 9% per year versus about 7% annually for stocks.

The list of alternative investments can be long, including just about any investable asset, such as:

-       Hedge funds

-       Private equity funds

-       Commodities

-       Real estate

-       Collectibles (such as art and antiques)

-       Angel investments in startup companies

-       And more…

And these assets can be quite powerful. Yale University famously committed a large portion of its endowment to alternative investments, particularly focused on private equity holdings, in the 1980s, and has to-date seen impressive results.[2] In 2014, for instance, it saw returns greater than  20% from this approach.

Dispelling the 5 Myths About Alternative Investments

But that hasn’t stopped some myths about alternatives from cropping up. They’re too risky… they’re too volatile, they’re not reliable. The list goes on.

Myth #1: Alternative investments are more volatile than stocks and bonds.

Reality: It really depends on the individual investment, but in our experience alternatives are more likely to reduce a portfolio’s volatility than the other way around. Just take a look at this chart from BlackRock:

Myth #2: Alternative investments are a unique asset class of their own.

Reality: Alternatives are simply any investments that can’t be easily categorized as stocks, bonds or cash. They really are more of a concept that represents different approaches to investing across a variety of markets and vehicles.

Myth #3: Investing in one alternative asset will effectively diversify my portfolio.

Reality: Diversification requires … diversity. Investing in only one alternative strategy may help with portfolio diversification, but it takes more than one to make a real difference. In fact, focusing solely on one alternative asset can also concentrate risks

Myth #4: Investing in alternatives means you can’t easily access your money.

Reality: Liquidity all depends on what you’re invested in. Yes, investing in real estate, for example, means that in order to access your capital you’ll need to sell or otherwise liquidate some of your holdings. But alternatives are all different, so this access varies from holding to holding and is no hard and fast rule.

Myth #5: Only institutional and ultra-high-net-worth investors can access alternatives.

Reality: This is our favorite myth to dispel. The truth is, although alternatives have traditionally been limited to accredited investors and other classes, today more individual investors than ever can access alternatives thanks to new products, new platforms, and new investment structures.  

And it’s all about opening up access to this growing and profitable asset class to as many investors as possible.

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