Considering alternative investments? Here’s an important piece of advice
I’m often asked, “What else can I invest in besides stocks, bonds, and cash?” Well, to the investment world, those “other” investments are referred to as “alternative investments.” Here is a brief list (not all-inclusive):
Real Assets - baseball cards, art, jewelry, metals, land, crops, livestock, etc.
Alternatives can be exciting, but don’t rush into them because you’re bored with your current portfolio. As I learned with Beck Bode, the world doesn’t always have to be mutual funds, ETF’s, and bonds. Your “traditional” portfolio can actually be exciting. If you are still looking outside those options, remember this:
If you want to explore alternatives, make sure your advisor leverages their subject matter expertise to put you in the best position to win. I’ll explain later in the post.
While “alternatives” are attractive because they have a mysterious, Wall Street-rainmaker appeal to them, they don’t make up the majority of most investors’ portfolios, and for good reason.
For one, they are usually tough to sell, and if they are hard to sell, it’s hard to earn a profit on them. As opposed to a widely traded stock like Apple, alternative investments aren’t as easy to liquidate. For example, let’s say you have a one-of-a-kind painting that you want to sell. It’s tough to put a price tag on it because there aren’t relevant comps (it’s one-of-a kind), and the demand is limited to those who appreciate that particular style of fine art. Low supply, low demand, and a high price tag mean you need a very specific buyer, and that makes it tough to sell.
Advisors who invest in alternatives generally have a limited amount of performance data readily available. Alternative investments aren’t as heavily regulated as stocks and bonds. Because of that, the advisor’s performance data is usually restricted to what they tell you it is. I don’t mean to be cynical, but you are at the mercy of the advisor’s word to some degree when they tell you how their alternative strategy performed.
Often, investing in an alternative investment will cost you more, but the returns could make it well worth the extra money. For example, a hedge fund manager will often charge you a management fee, much like the typical assets under management (AUM) fee, and on top of that they will keep a percentage of your profits. If the fund performs as it should, though, you will make more than you ordinarily would in a traditional stock/bond/cash portfolio, but if it underperforms, you need to be willing to stomach the loss.
Alternative investments are riskier than your traditional stock/bond/cash portfolio. In your typical stock portfolio, it’s highly unlikely for all the companies you own to go bankrupt. If that happened, you’d lose all your money.… and we’d probably be in the worst recession the world has ever seen.
However, there is a very real possibility when investing in alternative investments that you can lose everything. What if you invest in a venture capital fund that doesn’t return any winners? There goes that money. Or maybe you buy an option that closes out of the money and is now worthless. You can’t get that money back.
With limited performance data, low liquidity, higher fees, and greater risk, why would anyone invest in alternative investments? The short answer, you can make some good money if you do it right.
But how do you know you’re working with someone who knows what they’re doing?
Their alternative strategy needs to align with their subject matter expertise.
Let me repeat - their alternative strategy NEEDS to align with their subject matter expertise. I’ll explain.
If your advisor grew up on a farm, knows the ins and outs of crops and livestock - how the total rainfall per year can predict crop yields, how crop prices will vary because of that yield which in turn affects feed prices which in turn can affect milk production, livestock health, etc, which all ultimately affects the future value of the crop and livestock, and he/she invests in agriculture and livestock futures, there’s probably a good strategy at play.
If your advisor is an entrepreneur-turned-venture capitalist who has the unique understanding of what it takes to both successfully exit and successfully invest in a startup, and he/she utilizes an alternative strategy that focuses on venture capital deals, it sounds like their strategy lines up with their subject matter expertise.
At Beck Bode, we actively manage our clients’ accounts using an individual stock strategy. For a very small percentage of our clients, we leverage our expertise in individual stock selection, and instead of buying the stock, we buy call options on that stock, expecting that stock price to rise, and (hopefully) we finish “in the money.” In other words, we make money on that deal. It doesn’t always work out that way, but we leverage our subject matter expertise of individual stock selection in our alternative strategy, buying call options.
Ultimately, alternatives are a good addition to some portfolios, but they only make sense for those investors who a) have the stomach to ride the emotional rollercoaster they will take you on, and b) are willing to lose everything they invest.