Creating a Diversified Portfolio Beyond Stocks and Bonds
Creating an investment portfolio is a long-term journey that begins with a few simple investments. While the start of this journey can pose a challenge, it's oftentimes more difficult to figure out what to do next. If you believe that you aren't maximizing your investment potential, it's highly recommended that you look into diversification.
The right approach to diversification should boost the value of your portfolio and protect your assets against the kind of market volatility that regularly affects stocks. This strategy isn't limited to just stocks and bonds. There are many additional asset classes you should consider.
Alternative Assets to Consider for Your Portfolio
While stocks and bonds can be great additions to any portfolio, they don't provide enough diversification. Stocks have the potential to deliver high returns and help you grow your portfolio by a considerable amount in a short period of time. However, the stocks with the highest possible returns come with a high amount of risk. In comparison, bonds typically have low volatility but also relatively low returns.
Alternative assets like commodities, real estate, and collectibles provide additional benefits like risk mitigation and the potential for higher returns. These assets don't have a strong correlation with the stock market, which means that poor economic conditions won't automatically cause your alternative assets to lose some of their value.
There are several reasons why you should diversify your portfolio with alternative assets that go beyond the typical stocks and bonds you might otherwise invest in. Diversification involves placing at least two assets that move in different directions in the same portfolio. If your portfolio is highly diversified, a sharp drop in the value of one asset won't tank the value of your entire portfolio. This is a form of risk mitigation.
For example, let's say that you've invested in several companies that have been performing consistently well over the past few years. Despite a lengthy period of high returns, a downturn in the economy or a bad forecast for a certain industry can lead to company stock prices dropping precipitously at the same time. If your portfolio is diversified with real estate, commodities, and other alternative assets that are increasing in value at the same time, you'll likely be able to weather this storm without issue.
Benefits and Risks Associated with Each Asset Class
The many types of alternative asset classes you can add to your portfolio include:
- Real estate - This asset class involves investing in residential, retail, or commercial properties individually or via an investment trust.
- Commodities - Investing in commodities means placing your money into natural resources, which include oil, timber, and agricultural products.
- Collectibles - When you invest in collectibles like baseball cards, wine, vehicles, and other luxury items, you'll wait for them to appreciate in value before selling them.
- Private debt - You can invest some of your capital into a private company's debt for the purpose of making consistent returns.
- Hedge funds - These funds contain capital from numerous investors. The money is pooled together to invest in different securities with the goal of outperforming the rate of return for the overall market.
It's crucial to understand the many risks and benefits associated with these asset classes before adding them to your portfolio.
The primary advantages of investing in real estate include the following:
- Multiple return streams via appreciation and rental income
- Hedge against inflation
- Very stable investment in comparison to stocks
- Ample tax advantages
Some of the downsides to investing in real estate extend to:
- Bad tenants
- Credit risk after taking on high amount of debt
The primary advantages of investing in commodities include the following:
- Can generate high short-term profits
- Helps you diversify your portfolio
- Hedge against inflation
Some of the downsides to investing in commodities extend to:
- Can be volatile
- Downward trends for commodity pricing can last for a long time
- Storage fees may be required to hold physical commodities
The primary advantages of investing in collectibles include:
- You can invest in things you're passionate about
- Transfers through the collectible market are oftentimes confidential and unrecorded
- You can build a robust social network with other collectors
- These assets diversify your portfolio by avoiding correlation with the stock market
Some of the downsides to investing in collectibles extend to:
- Prices can be volatile based on the types of collectibles you invest in
- You can pay high taxes depending on the type of collector you are
- Collectibles with high returns usually have high costs
The primary advantages of investing in private debt include:
- Possibility of high returns
- Flexibility to invest in many different products
- Allows you to invest in markets that are usually inaccessible
Some of the downsides to investing in private debt extend to:
- Higher risk based on capital deterioration
- Assets are relatively illiquid
- Underwriting standards are low
- Credit profiles might be weak
The primary advantages of investing in hedge funds include:
- High flexibility since the funds aren't publicly traded
- Strong portfolio diversification tool
- Potential for high returns
Some of the downsides to investing in hedge funds extend to:
- High fees
- Lack of transparency
- Somewhat illiquid
Alternative investments give you the opportunity to develop a diversified portfolio that expands beyond the traditional stocks and bonds. At Attentive Investments, we can help you evaluate and incorporate these diversified options into your existing investment portfolio. Call us today to learn more about these asset classes and which ones are right for you.