The Role of Alternative Investments in Your Portfolio

Alternative Investments

For decades, pundits have taken a stab at writing the obituary for the traditional 60/40 portfolio (i.e. 60% stocks/40% bonds).

At first glance, this seems laughable. Over the last 90 years, a traditional 60/40 portfolio returned over 8% per year – like the S&P 500 which returned 9.5% over that period – but… with 40% less volatility!

However, these days, when accounting for historically low interest rates and rising inflation (which may or may not be transitory), the 60/40 bears may have their strongest case in recent memory.

This then begs the question: what now?

For a variety of reasons, there is still plenty of merit to 60/40 portfolios. However, we do appreciate the potential of certain investments to increase portfolio diversification. For investment opportunities beyond that of traditional stocks and bonds, we classify these in the portfolio as Alternative Investments (or, alts).

What are alternative investments?

Alts are essentially a catchall for any investment besides stocks, bonds, and cash (or cash equivalents). They provide an opportunity to gain exposure to areas not traditionally captured in a stock/bond portfolio that may or may not offer above market returns. Some of the more common types of alternative investments include:

  • Real Estate – crowdsourced or private commercial/residential property ownership, private/public Real Estate Investment Trusts (REITs)
  • Commodities – such as crude oil, corn, soy, wheat, and coffee
  • Precious metals – such as gold, silver, and lithium
  • Cryptocurrency – purchasing coins, NFTs, or investing in public companies at the fore of crypto/blockchain/web3
  • Private Equity – locking up funds with a private equity firm to invest in non-public, private companies often via leveraged buyouts and/or venture capital
  • Collectibles – tangible assets such as art, fine wine, and vehicles

What are the benefits of alternative investments?

  • Diversification. This is the primary benefit. Alternative investments are typically a counterweight to conventional stock/bond assets and may perform well even if stock/bond returns are poor due to low correlations.
  • May have greater upside. Alternative investments, often due to their concentrated positions, can potentially offer outsized returns compared to traditional mutual fund/ETF investments.
  • Expertise can be an edge. An example of this would be an experienced real estate fix-and-flipper who can spot an opportunity and has the team/know-how to carry out the vision. Another example might be an art collector that knows how to spot undervalued works of art. All this to say, unique skills/interests in niche areas can set you apart.

What are the drawback of alternative investments?

  • Illiquidity. Many alternative investments may be illiquid and difficult to exit. In the case of most non-tradable private REITs, your investment might be tied up for 7+ years before you can access the funds.
  • Lack of regulation. Reporting requirements for many alternative investments are minimal compared to those of public companies in the stock market. This can create difficulty when valuing the alt’s underlying assets, which can make pricing and price transparency less straightforward.
  • Investment platforms can fail. Many online platforms for alternative investing are start-ups that may or may not succeed. You need to understand how your funds will be handled should the company fail or be acquired.
  • Investment minimums may apply. High investments minimums are common and may make certain alts impractical/inaccessible for smaller investors.
  • High fees. Alternatives can have many fees that are unique to the investment. Private equity typically charges large asset management fees. Real estate can have many unplanned repair/maintenance/legal expenses. Wine collecting through Vinovest charges 2.5%-2.85% for climate-controlled and insured wine storage! Compare those fees to traditional index funds which have small expense ratios, no purchase fees, no redemption fees, and no 12b-1 fees.
  • Complexity. Alternative investments are often complex instruments and may require a higher level of due diligence. If you are considering alternative investments, you also want to be sure that you research and understand the potential tax implications associated with them.

Takeaway

Ultimately, investors need to be aware of both the upside and downside potential of any investment. The suitability of any given alternative investment should be considered against an individual investor’s:

  1. time horizon
  2. appetite for risk
  3. ability/capacity to take on outsized risk, and
  4. any unique skills/interests that strengthen the odds of making a profitable investment.

Cryptocurrency: Should I invest?

Crypto’s place in a portfolio:

Cryptocurrency has an identity crisis. Depending on who you ask, some view it as a security (like a stock), a commodity (like gold/oil), or a currency (like the US Dollar). Instead of adding to the semantics, we at wHealth Advisors take a more macro approach to crypto and view it simply as an “alternative asset.”

Besides cryptocurrency, some other examples of alternative assets are real estate investment trusts (REITs), art/collectibles, venture/angel/private equity investing, and commodities – to name a few.

Alternative assets can certainly have a place in the portfolio, however we always suggest minimizing personal expectations for investment returns. If you assume your alternative investment goes bust, how much does that hurt you (emotionally, financially etc.)? Does the loss impact your future goals, or is it just another blip on the radar? Similar to gambling, when it comes to alternative assets, only consider risking money that you are comfortable losing.

Depending on individual preferences/circumstances, an allocation of 0-10% of the overall portfolio to alternative assets can make sense. Additionally, and perhaps no surprise, but alternative assets are best suited for those with longer time horizons and/or higher tolerances for taking risk.

 So, should cryptocurrencies such as Bitcoin be a part of your portfolio?

For starters, investing in crypto is incredibly speculative. As we have seen over the past few weeks, a single tweet by a person of influence can spark extreme volatility. When taking a step back, there’s an argument to be made that cryptocurrency – and really, blockchain technology as a whole – is in its infancy a la the internet in the 80s/90s.

In some ways this is promising: the space will evolve, new entrants will emerge (and thus create new opportunities), and transactions will become more and more cost/energy efficient.

On the other hand, the larger and more mainstream this technology and way of transacting becomes, the more scrutiny it will be under (by domestic regulatory agencies and sovereign nations alike).

Before investing in cryptocurrencies, it is important to begin with the basics:

  • Have an emergency fund that is funded with 3-6mths (or more!) of living expenses.
  • Pay off any high interest debt.
  • Invest at least 15% of your gross income towards your long-term future (utilizing diversified mutual funds & ETFs).
  • Invest in your human capital i.e. your skills/career.

If, after satisfying the basics, you are willing to take on higher levels of risk and believe cryptocurrencies may be the next big thing, consider asking yourself the following questions:

  • How much am I willing to risk (i.e. between 0-10% of overall portfolio)?
  • What’s my endgame? How long will I hold? Or, at what target price will I sell?
  • Do I have a rudimentary understanding of cryptocurrency and blockchain technology?

If the answer to the last question is no – begin there.

Some resources to begin self-educating:

[PODCAST] Invest Like the Best: Chris Dixon and the potential of blockchain technology

[PODCAST] The Tim Ferriss Show: Balaji Srinivasan on the future of Bitcoin and Ethereum

[BOOK] Cryptocurrency Investing for Dummies

The Latest Investment Craze: Non-Fungible Tokens

Over the past month nonfungible tokens, or NFTs, have been all over the news. Saturday Night Live even got involved.

 What are they?

NFTs are cryptographic assets that are on the blockchain with unique identification codes and metadata that distinguish them from each other. Since they are unique, they cannot be traded or exchanged at equivalency, which differs from cryptocurrencies such as Bitcoin, which are identical to each other and therefore can be used in transactions (i.e. you can now buy a Tesla with Bitcoin).

 Why buy an NFT?

People are spending millions of dollars on NFT collectibles including artwork, digital images, sports cards, GIFs, music, video games, and other forms of creative art. By purchasing an NFT, you have a secure certificate of ownership over a digital object. As a collector, you are hoping that the value of the purchased item increases in value. For those that still remember the non-blockchain days, think of NFTs as a modern form of purchasing and collecting baseball cards. You buy them for your personal enjoyment and they may/may not appreciate in value.

 How to buy:

NFT’s can be bought on a variety of platforms, such as Nifty Gateway, Rarible, Open Sea, and The Sandbox. Each platform has an online gallery where you can browse, purchase, or bid on items in a similar fashion as an auction house. A purchase or winning bid is paid for with cryptocurrency. A digital wallet is necessary to store your purchase.

 Final thoughts:

NFT’s are relatively new. The current market is largely speculative and as with all markets, prices will fluctuate. In the modern and digital world we live in, NFTs will be another option for artists, creatives, and others to monetize their work, for collectors to purchase direct with fewer intermediaries, and for brands to establish their presence in the growing metaverse. Some further reading: