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What is an alternative investment? This term simply refers to an investment or asset that isn’t your normal stock, bond, or mutual fund. When I say alternative investment, most people think of real estate or hedge funds. This month let’s talk about the pros and cons of some alternative investments.
- Gold (or other precious metals) – This is a very hot topic with a lot of my clients right now. People seem to either love precious metals and allocate way too much of their portfolio to it, or don’t want anything to do with it. Very rarely do I see someone who has a reasonable allocation to a precious metal. The pros are precious metals don’t always move in alignment with the rest of the market. This makes it a great tool to diversify and mitigate some market risk. Within a certain limited period, precious metals have earned a decent rate of return. The cons? It is a tangible asset that isn’t as readily tradeable like a stock is. You must find a buyer and agree on a price if you want to sell the asset. It can also be very volatile.
- Real Estate – If you can read this, you have probably also read or heard that everybody makes loads of money in real estate and some lofty statistic that correlates millionaires to investing in real estate. The pros of real estate are the tax advantages, the cash flow opportunities, and potential appreciation. The disadvantages are, similarly to precious metals, it isn’t as readily converted to cash. It takes time to make real estate transactions, often include an agent that can add fees, there are expenses involved in owning real estate, and it takes constant management. The last one is the issue I have in recommending real estate to my clients. The commercials on TV and fliers in the mail advertise double digit returns while you sleep. Historically, cash flow has been the greatest opportunity for wealth building with real estate, not appreciation on it’s own. There is management, upkeep, repairs, replacements, finding tenants, etc. involved. To do it yourself is stressful. To hire out help eats into the returns. Real estate can be a good fit for investors who like to play a more active role in their portfolio. I just like to make sure their expectations are in alignment with the most likely reality.
- Art – This is probably the least liquid of the three alternative investments we have discussed. Art takes careful due diligence as the valuations and market size is much smaller than precious metals and real estate. As a result, I have only seen art acquired for lifestyle reasons more than investment reasons. If you enjoy art and it is something you want to invest in, consider working with an expert or two in the industry and don’t take shortcuts in researching before making acquisitions. Your greatest risk is probably overpaying followed by not being able to resell it at the valuation price. The risk of losing money due to actual lost value of the piece of art is smaller than those first two risks in my opinion.
If you have interest in alternative investments, but don’t have any experience yet, consider researching ETFs. There are ETFs that invest in commodities, in precious metal related companies, in real estate, etc. That is one way to gain exposure in your portfolio and some experience before committing to holding the physical assets.