At Realized, we believe in creating custom, diversified investment portfolios for our clients that are risk-adjusted and created to help investors pursue their unique income needs and investment goals. By applying the principles of Modern Portfolio Theory (MPT), we believe that we can help investors seek maximum returns within a level of risk suited to the investor’s risk appetite.
Modern portfolio theory was pioneered by Harry Markowitz, an American economist, in 1952 and published in the Journal of Finance. His work on MPT won him a Nobel Prize. The theory is a way to choose investments to help manage risk and potentially increase returns by diversifying a portfolio, focusing on the overall risk and return potential of a portfolio and not one lone investment. But for years, being diversified meant a balance between stocks and bonds. But today, we have many more investment options that allow for greater diversification. These investments are known as alternative investments.
We’ve developed this blog series as a way to introduce different alternative investments that may be a fit in an investor’s portfolio. By including alternative investments alongside traditional investment vehicles, investors can create a diversified portfolio that seeks to meet their investment goals.
Let’s take a look at some of the different kinds of alternative investments available.
What Are Alternative Investments?
Alternative investments are any investment outside of what is considered traditional investment categories like stocks, bonds, cash, and cash alternatives. At one time, alternative investments were primarily only available to high-net-worth and institutional investors, but they’re much more widely available to average investors today.
Examples of Alternative Investments
- Real Estate (Delaware Statutory Trusts, REITs, Qualified Opportunity Zones, raw land, co-working spaces, retail space, etc.)
- Private Equity
- Non-fungible tokens (NFTs)
Possible Benefits of Alternative Investments
Alternative investments are typically not correlated to the stock market, so they may perform differently relative to market ups and downs. Some alternative investments offer tax benefits or tax-deferment opportunities, which may allow you to keep more of your profits working for you. In some private alternative investments, you become a part-owner, so tax benefits are passed directly on to you.
Another potential benefit of alternative investments is you can invest in private alternatives with qualified retirement funds like 401ks or IRAs. Depending on how the investment is structured, you can seek to grow your investment tax-deferred or even tax-free.
While there are no guarantees with any investment, alternatives have the potential for higher returns than traditional investments.
Possible Risks of Alternative Investments
As with all investment types, there are risks associated with alternative investments. Alternative investments tend to be more illiquid. In some cases, alternative investments are more complex than traditional investments, so there may be a lack of knowledge or awareness related to how to evaluate them and incorporate them into your portfolio. Additionally, sometimes they have higher fees.
MPT and Alternative Investments
In its original form, MPT meant a split between stocks and bonds, usually 60/40. But we have so many more opportunities to further diversify with alternative assets.
The average investor’s portfolio holds just 5% alternatives while pensions and institutional investors (hedge funds, family offices, endowments) hold 27% and 29%, respectively.
The Yale Endowment, the world’s second-largest university endowment (after Harvard), is known as one of the best-performing investment portfolios in the world. Decades ago, Yale began investing more heavily in alternative assets. This shift saw the endowment grow from $1.3 billion in 1985 to $42.3 billion in 2021.
If you are looking to further diversify your portfolio, it may be time to consider alternative investments.
This material is for general information and educational purposes only. Information is based on data gathered from what we believe are reliable sources. It is not guaranteed as to accuracy, does not purport to be complete and is not intended to be used as a primary basis for investment decisions. It should also not be construed as advice meeting the particular investment needs of any investor. Realized does not provide tax or legal advice. This material is not a substitute for seeking the advice of a qualified professional for your individual situation. Diversification does not guarantee a profit or protect against a loss in a declining market. It is a method used to help manage investment risk. Alternative investments involve a high degree of risk, often engage in leveraging and other speculative investments practices that may increase risk of investment loss, can be highly illiquid, are not required to provide periodic pricing or valuation information to investors, may involve complex tax structures and delays in distributing important tax information, are subject to the same regulatory requirements as mutual funds, often charge higher fees which may offset any trading profits, and in many cases the underlying investments are not transparent and are known only to the investment manager. The performance of alternative investments can be volatile. There is often no secondary market for an investor’s interest in alternative investments and none is expected to develop. There may be restrictions on transferring interests in any alternative investment. Alternative investment products often execute a substantial portion of their trades on non-US exchanges. Investing in foreign markets may entail risks that differ from those associated with investments in the US markets. Additionally, alternative investments often entail commodity trading which can involve substantial risk of loss. All real estate investments have the potential to lose value during the life of the investment. All financed real estate investments have the potential for foreclosure. Cash flow or income are not guaranteed.