When you think of “investing”, what comes to mind? Did
you think of the US stock market? You might have thought about bonds or other
fixed income securities. What about real estate, commodities or other alternative
investments? Although less common, they can provide significant benefits when
combined with stocks and bonds. How can these investments benefit you? The
answer lies in their correlation, or relatedness to other investments. Alternative
investments typically have lower correlations with stocks and bonds; they often
“zig” when others “zag”. These alternative investments increase the overall diversification
of the portfolio, thus reducing risk (i.e., think fewer eggs in a single
investment basket). Below are some examples of alternative investments and the
importance of their inclusion within a portfolio.
Commodities
Inflation, or the general rise in prices, typically
reduces company profits due to an increase in costs (e.g., cost to borrow
money, cost of input materials, and cost of transportation). Commodities
typically increase in value when interest rates are steady or rising. They may
provide the investor a way to benefit when stocks are not performing well. Gold,
and other commodities, typically have very low and often negative correlations
with stocks. Commodities can also provide significant income from the
production and transportation of oil and gas.
Other Investments
Due to the finite and absolute necessity characteristics
of real estate, investors can benefit in a number of ways. Investors seeking
income may find Real Estate Investment Trusts attractive due to their high
yields. Others may prefer investments that benefit from the long-term
appreciation of property values. Foreign investments provide exposure to
markets less correlated to the United States; other economies sometimes expand
when the US economy contracts. Access to frontier and emerging markets allow
investors to benefit from faster growing economies and increased consumption
from an expanding middle class. Very small companies often provide niche
services or goods, frequently sheltering them from adverse events that affect larger
companies.
Commodities and other alternative investments reduce risk
by increasing exposure to a diverse set of asset classes. They frequently outperform
when US stocks and bonds fumble. Although they are typically a small portion of a portfolio, the
benefits of inclusion may be significant. In a diversified portfolio,
alternative investments should lessen the volatility of the entire portfolio.
Despite the correlation benefits, investors must realize that the individual
alternative investment may have greater risk than traditional investments.
Have you reviewed your alternative investments lately? We
at Paragon Financial Advisors look beyond the realm of US stocks and bonds,
seeking investment opportunities across the globe. Paragon Financial Advisors is a fee-only registered investment advisory company located in College Station, Texas. We offer financial planning and investment management.
