Should You Consider Alternative Investments In Your Portfolio?

You’ve probably heard that it’s important to have what we call “diversification among asset classes.” Strictly speaking, this simply means “don’t put all your eggs into one basket.” And that makes sense on many levels, because it’s almost never a good idea to make a bet on one single sector, or one asset class, or one stock, or one of anything else, because that raises your risk profile considerably.  

So it’s pretty common to see a portfolio with a fairly simple mix of stocks, bonds and cash.  People tend to view this as a good blend of “risk,” “less risk,” and relative safety.  And that works well for many people. But for certain individuals, something more may be called for. Maybe a little added diversification.  This is where the idea of alternative investments comes into play. 

So what is an “alternative” investment? A good definition might be an investment with non-correlating, and negative-correlating, risk characteristics. But what does that mean?  

If you’ve got an asset in a portfolio that’s headed in a downward direction, it can be benficial to have a different type of asset that may head in an upward direction (or at least non-downward direction) given the same circumstances – what we call the “zig and zag” approach.   

When we talk about “asset correlation,” it refers to how and when investments move in relation to each other. When you have assets that tend to move in the same direction at the same time, they are said to be highly correlated. When one asset tends to move up as another goes down, those two assets are described as negatively-correlated.  Investments that don’t necessarily move in any specific direction just because other investments are moving are called non-correlated assets.   

A portfolio with a mix of all of these types of assets may help reduce the overall volatility of the portfolio. 

Alternative investments – by which I mean anything other than traditional stocks, bonds, or cash – can include things like real estate, commodities, private debt, and so forth. One reason to consider including them in your portfolio would be to counter the price movements of a traditional investment portfolio, thus potentially reducing the risk in that portfolio.  

One important aspect of the Bucket Strategy involves minimizing downside risk, which is one of the chief characteristics of adding alternative investment strategies.  Ideally, investment managers try to generate positive returns, irrespective of the direction of the market, and alternative investments may be one way to do that.  Of course, there’s no guarantee that this will happen, but the potential for more positive returns is somewhat greater with alternative investments in the portfolio, and reducing the risk may help achieve a more consistent overall return. 

Keep in mind that this does not mean that everyone should have alternatives.  Just by themselves, they may carry a lot more risk than some individuals can tolerate, and if that’s the case for you, it’s best to stay away.  If you’re going to include them, you should do so as part of a diversified portfolio. But even if alternative investments aren’t suitable for you, smart diversification may still help to reduce your risk and increase your return over time when done properly. 

If you’d like to find out more about alternative investments, and whether they’re suitable for your situation, contact us here at Lucia Capital Group, and we’ll be happy to take a look.  How can we help you the most? Just give us a call.