Alternative investments: What do financial terms mean Series

This post continues the series – What do financial terms mean:  Alternative investments?

An alternative investment is any investment product other than the ownership of investment products such as stocks, bonds, cash or real estate. Other posts have discussed what a stock is – ownership in a company, and what a bond is – lending money to a company or government.

Specifically this post will address two questions:  what are examples of alternative investments?,  and should I own them to help diversify my portfolio?

chip mill

Common examples of alternative investments are owning precious metals such as gold or silver, pieces of art work or antiques, as well as coins and stamps.  Some people even collect wines, but we would not be one of those investors as when we purchase wine, we tend to consume it soon after it arrives at the house.

Institutional investors such as large college endowments are known for purchasing alternative investments such as forest/timber holdings, commodities and private equity.  These investors hire consultants to give them quite a bit of knowledge in each of these areas which allows them to benefit from this ownership.  These investments tend to be illiquid or tough to turn into cash in the short term without significant potential loss in principal.  They are not as concerned about the illiquid nature of their investments because they have time frames that in most cases will go on for decades.

Do we have our clients invested in alternative investments? No.  There are a few reasons that we do not invest or recommend that our clients invest in these alternatives. The most important reason is that the publicly traded securities give most individual investors as well as most endowments, the ability to invest in over 10,000 different holdings.  These holdings are located in 44 different countries allowing for as much diversification as they need to achieve their goals.

We do invest for our clients in the real estate market, but this is also done in the globally traded stock market where we can get exposure to real estate investment trusts and homebuilders where the largest real estate companies are publicly traded.

Other reasons that we do not recommend these investments include the illiquid nature of these instruments as well as the fact that most individuals do not have the means necessary to be a major player in the  alternative investment universe.  In this marketplace, the costs to purchase ownership, as well as to sell the ownership, tend to be relatively high.  Even if you’re able to go to the buffet line with the bigger players by the time you get through the line, the big players have already taken all of the filet mignon and lobster and you’re left with the scraps left over on the table.

Lastly, and probably most importantly, the returns generated of the publicly traded capital markets should be should be sufficient for you to achieve what it is you’re trying to achieve.  As we have often stated,

the challenge for most investors is not what investments they own, but being able to maintain the portfolio of investments in a well diversified portfolio through the various market cycles.  People fail not because they don’t own alternative investments, but because they allow emotions to overcome their decision-making.

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About Dan Crimmins

Dan Crimmins, co-founder of Crimmins Wealth Management, is a financial coach and fee only financial planner. Have a financial question? ASK DAN

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