The Important Roles Alternative and Traditional Investments Play in Your Portfolio
By Denis Shapiro
Too many times, investors develop an all-or-nothing philosophy when it comes to investing. I’ve met many investors who believe that traditional assets are the only legitimate means of investing, and when I mention alternative investments, they instantly roll their eyes because they mistakenly associate them with high-pressure “boiler room” operations. On the flip side, I’ve met many alternative asset investors who believe that investing in Wall Street is a fool’s game because they’ve either been burned by a market collapse, or they just don’t trust the stock market.
The truth is, there really is no one-size-fits-all formula that explains where people should invest their money because it is a very personal decision—as it should be—and every person has different needs, goals, and risk/reward tolerances.
(Note: Read on if you already have a basic understanding of what traditional and alternative investments are. If you need a primer on this, you’ll want to head over to our An Introduction to Alternative Investment Series.)
What’s “Better” — Traditional or Alternative Investments?
When you begin your investing career, traditional investments have some unique advantages over alternative investments. As a starting point, you can buy one share of a low-cost index fund and instantly receive diversification from a wide spectrum of assets. Since you have the choice of investing in the entire market, you don’t have to spend time researching individual stocks and can largely set your portfolio on autopilot. The time and energy you conserve allows you to pursue other life obligations, and the value of that can’t be understated since most people would agree that time is our most important asset in life.
The major drawback to this strategy, however, is that as you get closer to retirement, you may find that a low-cost index fund portfolio may not produce the income needed for your retirement years. The current yield for most index funds is 1–2%, while the current benchmark withdrawal rate is 4%. The difference would made up by selling a piece of your portfolio every year.
In short, a low-cost total market index fund is a simple, extremely time-friendly strategy, and when left alone to compound earnings, it is brutally efficient at creating wealth if you avoid selling in downturns. However, the yield and income leave much to be desired.
As you progress in your investing and working career, alternative investments become a much more viable option—especially when you reach what’s called “accredited” status. Alternative investments encompass a wide variety of assets, but there are a few that have become most popular among investors in our network:
It’s important to understand that when you venture into the world of alternative investments, the time savings you’ve earned from having a traditional portfolio on autopilot will need to be reallocated.
While some in the industry have coined terms such as “passive investing,” with the implication that investing in certain assets is truly hands off, this is simply not the case: Alternative investments require a significant time commitment.
First, you’ll need to learn the language of any investment you are contemplating. Luckily, some investors already know these languages, such as a tech employee investing in a tech startup or a commercial real estate broker investing in an apartment building. But new investors might not be so fortunate, and they may need to take a considerable amount of time to learn the industry jargon. The silver lining is that the time commitment needed tailors off considerably if you in stay in your zone of competency. For example, an investor who spends a year learning multi-family investing can make a quick transition to other commercial real estate asset classes like mobile home parks or self-storage. Conversely, apartment building investors will not enjoy the same efficiencies should they get into fine art or collecting watches.
Second, you’ll need to build out a network of other investors and operators that you can rely on for critical information. There are no shortcuts here, as there are no analysts covering a specific deal that you’re eyeing. The good news is you can learn the language and build out your network simultaneously.
Now, let’s look at what makes alternative investments so special.
When you invest in an alternative asset, you’re adding protection against the random volatility seen on the stock market. Alternative investments, by definition, are assets that are not traded on the stock market. This makes the private market for alternative assets pretty much illiquid, which creates low volatility in the secondary market.
The second major advantage of alternative investments is the ability to generate a higher yield. While this is not true across the entire alternative investment spectrum, there are many investment options that create yields that are significantly higher than traditional assets. You might be thinking, “But, wait, there are high-yield options traded on Wall Street as well, like REITS, MLPs etc.!” That is true. However, the instability of those yields during market downturns is frightening. One only needs to look back to March 2020 to see scores of examples of dividend cuts and suspensions as well as equity declines totaling more than years of yield distributions all erased in one month. I am a firm believer that volatility is the archenemy of yield—at least yield that can let you sleep at night.
In March 2020 in the alternative world, this was not the case. While there was some sense of uncertainty, the lack of liquidity allowed cooler heads to prevail, and (for the most part) the distributions continued.
A Final Note
A huge “Eureka moment” occurred to me when I stopped looking for the perfect strategy.
Instead, by asking myself these questions about my portfolio: Is it too risky? Does it need to be more diversified? Does it provide enough appreciation? Is it too complicated? Does it provide enough cash flow? I learned what I was looking for was already there since I already invested in both traditional and alternative assets. I just needed to create a better balance among them within my own portfolio.
There are so many options out there, and none can be definitively deemed the “best” option, but one thing is certain: Traditional and alternative investments complement each other far more than diehard proponents of either side would like to acknowledge.
If you liked this article and wish to continue on your path in learning about alternative investments, please make sure to check out my other educational articles as well as my book, The Alternative Investment Almanac: Expert Insights on Building Personal Wealth in Non-Traditional Ways.
Disclaimer: The information presented in this article is for informational purposes only and does not constitute professional financial or investment advice. The author does not make any guarantees or promises as to the results that may be obtained from it. You should never make any investment decision without first consulting with your own financial advisor and conducting your own research and due diligence. Even though, the author has made reasonable efforts to ensure that the contents of this article were correct at press time. The author disclaims all liability in the event that any information, commentary, analysis, opinions, advice and/or recommendations contained in this article results in any investment or other losses. Your use of the information in this article is at your own risk.