Connecticut Money: Is there a place for alternatives in your portfolio?
This article was published in the New Haven Register on August 14, 2020.
Today it’s a simple matter to dedicate a portion of your investment portfolio to asset classes
outside the conventional core trio of stocks, bonds and cash.
Historically, most alternative investments were out of reach for the ordinary investor.
Buying into hedge funds or investing in timberland required deep pockets and status as an
accredited investor.
With the advent of exchange-traded funds and alternative-based mutual funds, times have
changed. Today it’s a simple matter to dedicate a portion of your investment portfolio to
asset classes outside the conventional core trio of stocks, bonds and cash.
The type of market volatility we have experienced since the start of the coronavirus
pandemic in March highlights the need to diversify your portfolio. You can achieve a high
degree of diversity within the three core asset classes, for instance by increasing the
percentage of cash or bonds. Another option is to change the mix within a class, e.g.,
transferring some funds from small-cap to large-cap mutual funds.
Alternative investments offer another way to diversify, because these asset classes may rise
and fall in opposition to stock and bond markets. In other words, when the stock market
falls, some so-called “alts” will rise in value, and vice versa. This “low correlation” may help
limit losses and smooth out your investment results over time.
Popular alts include gold, silver, real estate and collectibles (art, wine). Other categories,
generally limited to more sophisticated investors, include hedge funds, private equity,
venture capital and managed futures. There are also opportunities to invest in energy
(natural gas, oil) and agriculture (corn, wheat).
It’s important to remember that alternative investments should make up a relatively small
percentage of your overall portfolio, perhaps 3 percent to 10 percent, as they can be more
costly than traditional investments and also can be more volatile and carry more risk. On
the other hand, they may enhance your overall portfolio.
If you are wondering what percentage of your portfolio you should invest in alternative
funds, it depends on your time horizon, net worth and risk tolerance. For example,
younger investors might consider a higher percentage than someone closer to retirement,
given the higher costs and risks, since they have more time to make up any losses.
A Certified Financial Planner can help you decide whether to invest in alternative asset
classes, which assets to choose and what investment vehicles to use. A financial adviser will
look at these questions in view of your broader financial planning picture and your
retirement planning goals.
Alternative investing is a complex field. For example, there are now more than 130 ETFs
that invest in commodities such as precious metals, energy and agricultural goods.
There are four types of commodity ETFs: Equity ETFs invest in commodity-related stocks;
exchange-traded notes (ETNs) track securities indexes; physically backed funds hold
commodities such as gold in storage; and futures-based funds trade in futures, forwards
and swap contracts related to commodities. Some commodity ETFs utilize “laddered”
strategies while others pursue “optimized” strategies. It takes a financial planning expert
to sort through the bewildering array of alternative investing options available to the
modern investor. Please keep in mind that diversification does not ensure protection in
down markets. It is not a “silver bullet” despite the many pundits who speak to it.