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.
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.
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.