When it comes to investment strategies, most investors are familiar with traditional options like stocks, bonds, and mutual funds. In a recessionary economy and volatile market cycles, like the one we’re currently experiencing, these traditional strategies can leave investors feeling dissatisfied and anxious. However, implementing an alternative investment system alongside their traditional portfolio may provide long-term stability and growth. Alternative options can have a lower correlation with the stock market and can offer diversification benefits to a well-rounded portfolio. In this blog, I’ll go over why, in today’s economy, it may be worth rethinking how your investment portfolio is set up and considering alternative options as part of a comprehensive investment strategy.
Traditional investment strategies: the upside and downside
Traditional investment strategies focus on maximizing returns and minimizing risk through diversification, spreading your investments across many different asset classes. They often involve a mix of stocks, bonds, and cash using mutual funds or exchange traded funds (ETFs).
The Upside: One key aspect of traditional investment strategies is asset allocation. This involves dividing a portfolio among different asset classes in order to spread out risk and optimize potential returns. For example, you might allocate your stock investments in large, medium, and small companies. Another important factor is the time horizon, or how long the funds will be invested for. Traditional investment strategies prioritize long-term gains over short-term profits, as they have been shown to yield better results in the end. Oftentimes a traditional investment portfolio will use bonds to offset the risk of stocks, so you get a mix of stocks and bonds, for example, a 60/40 stock to bond portfolio.
The Downside: It’s often joked that a well-diversified investment portfolio leaves an investment advisor or financial planner to constantly apologize. This is because the investor may focus on the one or two investments that are up or down and say, “Well why didn’t we put more in that fund?” or “Why were we invested in that poorly performing one?” Since late 2021, stocks, especially high growth technology companies and bonds, have been under significant pressure due to the changing economic landscape. This is influenced by several factors, including historically high inflation and aggressively rising interest rates, which have raised borrowing costs, decreased economic stability, and reduced the buying power of cash. This has resulted in unpredictable and violent swings in the stock and bond market.
Many investors have their hands up wondering what to do next. If this sounds familiar, then it might be time to look at how an alternative investment strategy could help your investments.
Reasons why alternative investments can be particularly attractive during times of economic recession
The term Alternative Investment can mean many things but for this article I’m referring to investments that don’t fall into traditional stock and bond definition, like real estate, private equity and debt, commodities, and hedging strategies. These options may offer enhanced returns, diversify risk, or supplement your income.
Many alternative investments have low correlation with the stock market, meaning they tend to perform differently and have a lower sensitivity to market indexes like the S&P 500, for example. This can help stabilize a portfolio and protect against losses in the stock market. Also:
- Alternative investments often offer a different risk and return profile than traditional investments. This can be true in a recessionary economy, when stock prices are down, and interest rates are low.
- Alternatives may provide diversification benefits to a portfolio. When stocks are highly volatile, they may help balance out the risk in a portfolio.
- Some alternative investments are less liquid than traditional investments, meaning they can’t be as easily bought and sold. This can be seen as a positive or negative depending on your investment goals. If you’re looking for short-term gains, illiquidity may not be ideal. But if you’re focused on long-term growth, illiquidity can actually be beneficial because it gives you a chance to buy low and sell high.
- Access to alternative investments historically has been limited to ultra-high net worth individuals and families, and institutions. Today, many average investors can invest in non-traditional investments using vehicles that allow for lower buy ins and greater liquidity.
Of course, alternative investments come with their own set of risks that need to be carefully considered. Despite the risks, alternative investments can be a valuable addition to any wealth management strategy, especially in today’s economy, as they may offer stability, growth potential, and diversification benefits that traditional investments can’t match.
What to keep in mind before investing in alternatives
Before making any decisions about investing in opportunities in real estate, private equity, private debt, or hedging strategies it’s important to understand a few things – and consult with a financial advisor. Here are a few things to keep in mind:
- Make sure you understand the risks involved and your own risk tolerance. Some investments come with the potential for higher returns but also greater volatility.
- Consider your financial goals. Alternative investments should be part of a well-rounded portfolio that meets your specific financial goals. Don’t put all your eggs in one basket.
- Consider the fees involved. Many alternative investments come with higher fees, which can eat into your profits.
- Consider your time frame. Are you investing for the long term, such as retirement, or do you need more liquidity for short term goals?
Adding alternative investments to your comprehensive strategy
Many investors choose to stick with the traditional route of public stocks and bonds, and that’s okay, but there are numerous benefits to diversifying into non-traditional investments. Let me give you some stats I’ve seen recently with current and potential clients. Due to recent fluctuations, I’ve seen people with traditional investment portfolios panic when their losses start to mount beyond their comfort level, while clients that have alternative investments have fared significantly better. Let’s break it down by type of investment:
Private Real Estate – Private real estate can offer a more stable and tangible source of income. Typically, investors can access private real estate by buying shares of an investment vehicle, typically in a structure called a REIT (real estate investment trusts). Through these funds investors may enjoy more consistent cash flow and access to unique properties without having huge sums of money or the deep knowledge it requires to complete the necessary due diligence in a large real estate transaction. In addition, properties may appreciate over time, providing potential for long-term financial growth.
The key to evaluating these types of funds is to look at how the fund is structured and what type of properties they invest in. Fund structure might look at how liquid your shares are, how much debt the fund can take on, or how the fund managers are compensated for their performance, among many other factors. Types of properties might be a mix of A-class office buildings, strip malls, multifamily, light industrial, or triple net leased properties, to name a few.
Private Debt – Investing in private debt means lending money to private companies, which can offer a different risk and return profile than traditional bond investments. These loans are typically structured with specific terms and a set repayment schedule with access to various levels of the capital stack. Like the real estate investment mentioned above, private debt is best accessed through a fund and similar considerations should be taken. Private debt investments come with their share of risk and it’s best to lean on professionals to handle the due diligence on where and how to invest. In addition, a diversified portfolio of private debt investments can offer stability and steady income for the long term.
Private Equity – Unlike publicly traded securities, private equity investments may be insulated from fluctuations in the stock market. This may provide greater stability and the possibility of long-term growth as the companies in which you invest continue to develop and expand. In addition, because private equity investments often focus on small or startup businesses, they can offer unique opportunities for high returns as those business ventures succeed. Private equity also offers access to a wider range of industries and investment strategies, providing more opportunities for diversification.
Managed Risk/Hedging: Another option to protect your portfolio in times of economic struggle is to incorporate risk-managed investments. These portfolios are designed to limit losses during periods of market downturn, while still allowing for potential gains in favorable conditions. As always, it’s important to assess your personal risk tolerance and goals before making any changes, and it’s also important to note that this strategy should not be seen as a guarantee against losses, but rather as a tool for mitigating potential risks. While no investment strategy is foolproof, including risk-managed portfolios can help cushion the impact of a volatile market on your overall portfolio.
While they may come with more complexity and may require a longer time frame for returns, considering private investments can result in a well-rounded portfolio with diverse sources of potential growth, income, and risk protection.
Implementing an alternative investment strategy into your portfolio
Here are a few things we’ll do before creating a well-diversified portfolio that includes alternative investments:
- Understand the risks and potential rewards associated with these types of investments.
- Evaluate the various types of alternative investments, including private equity, private debt and real estate, and hedging.
- Determine whether these assets align with your long-term investment goals and risk tolerance.
- Create a personalized strategy.
- Strive for balance by maintaining a mix of traditional assets such as stocks and bonds in addition to alternatives, if necessary.
A shift towards mindful wealth: avoid riding the wave of growth
How you decide which type of alternative investment strategy is right for you depends on your personal financial situation and goals. While I know it can be tempting to focus solely on growth and the potential for high returns, placing too much emphasis on stock growth can lead to risky investments and potential losses. Many times, investors get enamored with high growth investments, like we’ve seen in technology industry recently, and unfortunately get burned when those investments crater.
A shift towards mindful wealth – where you value long-term stability and sustainability with a degree of growth – can have a more positive impact on your portfolio in the long run and potentially allow for success in any market conditions.
Wondering how rethinking your portfolio could help you? Let’s talk.
As a Certified Financial Planner®, I have a fiduciary responsibility to only recommend what is in my clients’ best interest. You can rest assured knowing that if I’m supporting you in managing your money, I’ll give you the best recommendations for you at that moment.
If you would like to explore what rethinking your portfolio can do for you, feel free to reach out to me at: info@FourPointsWealth.com or (303) 910-9751. I am always happy to be an informal sounding board to answer any questions you might have.
Advisory services are offered through CS Planning, Corp., an SEC registered investment adviser
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