The One Reason You Should Consider Alternative Investments

Adding alternative investment assets to a portfolio can potentially provide a boosted overall return while reducing volatility. Over the past decade we’ve learned about asset correlation from some unique market conditions, and now it’s time to apply this knowledge to your portfolio. What if you’re taking too much risk for the return you’re experiencing?

Here’s why: many traditional asset classes tend to move in tandem during times of volatility. Think 2001-2002 and 2008-2009 when investment portfolios saw their high value degrade to the lowest level (peak-to-trough). During this time, essentially all the investments in a traditional portfolio moved in the same direction…down! This makes building a truly diversified portfolio a greater challenge.

Less correlated alternative investments help adjust the risk/return characteristics of investment portfolios. Very simply, over time we can seek higher returns while preventing the extent of the emotional highs and lows of our portfolio.

Portfolio Theory
Traditional investment asset classes have been stocks, bonds, and cash. Portfolio theory has shown that when stocks fall, bonds can offset that with a boost to the value of the account. When bond prices fall, stocks usually garner the momentum and pick up the slack. But as we’ve seen lately, these characteristics don’t always hold true in times of extreme volatility.

Highs and Lows
To reduce overall risk, we have to measure and find a way to lower standard deviation. Standard deviation measures how far up or down from the average a portfolio moves, basically giving us a window into the risk of the portfolio. With an investment, we look at the extent of how extreme the highs and lows travel. Lower volatility means we can be confident in the trend we’re participating in and our strategy is on track.

Alternatives Defined
Most alternative investment assets have been traditionally held by institutional investors or accredited, high-net-worth individuals because of the sheer size of minimum investment needed to access these strategies. They include global real estate, natural resources, currencies, listed private equity, commodities, global infrastructure, and private lending. There are also alternative strategies such as covered calls, managed futures, and arbitrage.

With so many compelling reasons to include these asset types into an individual investors’ plan, there are now a number of established opportunities to access alternative investments. The financial industry has created unique opportunities for lower minimum account sizes, and independent advisors have can establish portfolios where these are included. In many cases with a modest account size, individual investors can gain direct access to these strategies (even with as little as $5,000).

The point here is that the investing landscape has changed and continues to change. We must be vigilant with due diligence, but where appropriate, alternative investments can make a tremendous impact on the value of your portfolio as well as your emotional health.

Have you considered adding alternative investments to your portfolio? Do you currently have alternative investments as a piece of your overall plan?