The investment landscape has changed dramatically over the past few years. What has historically been a reliable way to build wealth – increased trust in indexing, dumping cash into E-minis and calling it a day – feels as if it’s not operating as predictably as it once did. Inflation, skyrocketing interest rates and war internationally have made society confused about where their next dollar should go. They’re now pooling money into cryptocurrencies and digging for gold, not literally, but research shows that less and less investors have all their money sitting in the stock market.
What’s Happening: Many seasoned investors are diversifying across more asset types that move differently than the stock market. This isn’t diversification for the sake of asset protection; it’s realizing that other avenues may produce better than anything financially safe and guaranteed to get return without the wear and tear of economic fluctuations.
The Problem with Stock-Heavy Portfolios
When someone starts investing, more than likely their portfolio looks the same way their parents’ looked. Buy a few mutual funds; throw in a few stocks; and pray. This concept may work for a staple portfolio but falls incredibly short when times get tough. For example, if the stock market closes down 500 points one day, that investor has a huge chunk of their portfolio dug into one black hole. Tech stock investors, value stock investors and growth stock investors suffer because they all move together during historical bull or bear markets.
Furthermore, investors make their investments each year as stock prices become more and more expensive. Price-to-earnings ratios that would have seemed outrageous ten years ago now characterize a standard American capitalist.
Therefore, in addition to financial risk, far fewer opportunities exist for high return potential today.
Real Estate: The Alternative that Makes Sense
One of the most common alternatives institutions have been flocking toward lately is commercial real estate. Unlike residential properties that most people are familiar with, commercial property singapore and other markets offer different risk and return characteristics that can complement a stock portfolio nicely.
For example, commercial real estate provides consistent income through cash rent payments. Even when times get tough and companies scramble to reduce overhead costs by letting employees go – and stock dividend payments cut as a result – most commercial tenants (think: CVS, Starbucks, Dunkin’) are locked into multifamily units. This locks in reliable cash flow; not to mention, tenant leases usually increase monthly/yearly in line with inflation.
Even the property values move differently than stock price movements. Real estate operates in a bubble; based on geographic location, population demand, interest rates – many factors may impact value apart from what stocks are doing on any given trading day. This means that commercial properties may hold value or even increase in value apart from what’s happening at Wall Street.
What Else Is Out There?
Beyond real estate, there are tons of alternative assets investors add into their portfolios. Each alternative brings something different to the table in terms of risk, return and correlation or non-correlation capacity to traditional offerings.
For example, commodities exist as a major resource class and behave and move differently than stocks – for example, gold as an investment will never be worth more than what its weight in gold is on its own. Agricultural products hold supply and demand potential based on weather trends or lack thereof – when inflation is skyrocketing, commodities perform well while stocks tank relative to price increases based on scarcity. They tend to perform better at certain economic cycles when companies that produce raw goods need more workforce help.
Private equity investments give access to non-public companies that portfolio holders invest in private equity/Venture Capital Disciplines (which can produce higher returns than public stocks) and take longer periods to realize/consider risk. Wealthy individuals allocate the private portion of their portfolios as investments they’ve amassed over years but cannot buy through traditional means.
The Income Aspect
One of the best reasons for alternative investments is reliable cash flow generation through mass amounts of income. Historical dividends from stocks have accounted for a smaller percentage of total return nowadays – even with increased dividend payment success rates – yet alternatives primarily exist to provide consistent cash flow yield.
For example, real estate investment trusts (REITs) must pass along distribution from most of their cash flow to investors who generally receive higher dividends on higher-value dividends than average stockholders appreciate. Similarly, master limited partnerships typically subsidize appealing distributions – but these partnerships require added tax responsibility.
Real estate also offers income-generating potential based on type (office generates market rent over time with corporate contracts while retail properties may offer percentage rent).
Managing Risks Accordingly
The biggest challenge when trying to round out an appropriately diversified portfolio is that it’s way easier to acquire a portfolio and forget about it than it is to learn about each alternative option compared to indifference and price.
Every alternative asset class comes with its own caveats: cash flow potential, need-to-know knowledge about percentages allocated, timing of inception and realization for performance.
Many investors work through financial advisors who focus exclusively on alternative investments or through funds who operate them on an actively managed basis. Real estate funds, commodity ETFs and private investment platforms have made it easier than ever for even first-time individual investors to enter these markets without having to become experts themselves.
The tax considerations are also tricky compared to typical alternatives – for example, real estate might generate depreciation benefits while commodity investments deliver different costs than capital gains.
Thus, professional opinion runs far more important relative to dollars spent within niche assets when they’re approaching sophistication status.
Diversification is Key!
The goal shouldn’t be to sell everything stock-oriented; instead it should be to enjoy a portfolio that performs well no matter the investment climate. Historically, 60-70% of portfolios would be properly invested with traditional stock/bond allocations; 30-40% has since rounded out assets based on personal financial goals/interests.
This diversification takes time; alternatives aren’t always immediately justified. Sometimes they work independently or contrary to expectation – but for those investors who leverage expectations independent of the playbook mindset, they’ll find gratification in diversified potential as part of regular cash flow access.
The world continues to change by the decade. Investors need to keep up! Time will tell if people historically make millionaires off stocks solely – but money-makers will surely enjoy integrated successes going forward no matter new avenues of investment manifestation.
