It is smart to keep your investment eggs in as many baskets as possible. But you don’t need to look for anything exotic like alternative investments to diversify your portfolio.
An alternative investment is any product other than standard vehicles such as stocks, bonds, cash or real estate. Common examples: precious metals like gold or silver, artwork, antiques, coins and stamps. Some people even collect wines, though most of us prefer consuming it soon after it arrives at the house.
There are a few reasons that we do not recommend that our clients invest in alternatives. The most important is that publicly traded securities give most individual investors the choice of thousands of different holdings in dozens of different countries, allowing for as much diversification as they need to achieve their goals.
For instance, you can invest in the real estate market on global stock exchanges, where you can get exposure to real estate investment trusts (REITs) and home builders. Many of the largest real estate companies are publicly traded.
Another reason to avoid alternatives is their illiquid nature. Institutional investors, such as large college endowments and pension funds, often purchase alternatives such as timberlands, commodities and private equity stakes. These investors hire consultants to research each of these areas, which few individuals can do.
Plus, alternatives tend to be illiquid, meaning that it is tough to turn into cash in the short term without significant potential loss in principal. Huge institutions are not as concerned about the illiquidity because they roll on for decades on end, and don’t face retirement dates, as ordinary investors do.
Most folks do not have the means to be a major player in the alternative investment universe. In this marketplace, the costs to purchase ownership, and to sell it, tend to be relatively high. It only works at a massive scale. Even if you’re able to go to the buffet line with the bigger players, by the time you get through, they have already taken all the filet mignon and lobster. You’re left with the scraps. Don’t delude yourself into thinking you can outsmart them.
Lastly, and probably most importantly, the publicly traded capital markets’ returns should be sufficient for you to achieve all your financial goals. [highlight] The challenge for most investors is not what investments to own, but maintaining a well-diversified portfolio in good and bad market cycles.[/highlight]
People fail not because they fail to own alternative investments, but because they allow emotions to overcome their decision-making – and they buy the wrong things.
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