This article is reprinted by permission from NextAvenue.org.
The first rule of investing wisely is diversification. Hold a portfolio of stocks and bonds, financial advisers say, because if stocks go down, your bonds will come to the rescue and vice versa. Well, not this year.
In 2022, stocks and bonds have generally been pummeled. The S&P 500
index (a basket of the 500 biggest U.S. stocks) is down more than 20%. And 10-year Treasurys
(the benchmark for intermediate-term bonds) have lost more than 15% of value due to soaring interest rates; when interest rates go up, bond prices go down.
‘The year we’ve been scared of’
“This is the year we’ve been scared of, and now we’re having it,” Anastasia Amoroso, chief investment strategist for the global financial firm iCapital, said at a recent Morningstar
The dog days for the stock and bond markets are leading some investors to put money into what are known as alternative investments, hoping that they will produce decent returns.
At least 15 new alternative-investment products will be available in the next nine months, Steffen Paul, founder of the Moonfare investing platform, recently told the Financial Times. And a NASDAQ study predicted the alternative investment market could reach $17.2 trillion by 2025.
Should you take the plunge?
Related: Why alternative investments belong in 401(k) plans
What are alternative investments?
“There’s a whole big category of these other investments that wear the label ‘alternatives,’” said Pam Krueger, founder of the financial adviser vetting service Wealthramp on the latest episode of the “Friends Talk Money” podcast. (Full disclosure: I’m a co-host of the podcast along with the personal finance syndicated columnist and author Terry Savage.)
Alternative investments include cryptocurrencies, gold and other commodities, income-producing real estate, private debt securities and private-equity funds.
Some can be bought only by “accredited investors,” which the Securities and Exchange Commission defines as people with at least $200,000 in income ($300,000 for married couples) in each of the past two years or a net worth of more than $1 million, excluding their homes. And some “alts” require minimum investments of $75,000 or more, though lately there’s been a push to lower minimums and open more alternative investments to the general public.
Stocks and bonds aren’t your only investment options. There’s a whole universe of alternative investments, including natural resources, precious metals, private equity, hedge funds and managed futures. Here’s what you need to know.
The search for returns
“With stocks and bonds having been on a downward trajectory here for a while, people are asking: ‘Can I please have something in my portfolio that isn’t dropping? That I’ll be able to look at and actually have a smile on my face when I look at the actual results?’” Erik Olson, a financial adviser at Arete Wealth Management in Chicago, said recently.
In a recent survey of financial advisers by CAIS, an investment firm, over three-fourths of respondents said they felt the traditional portfolio of 60% in stocks and 40% in bonds is “ineffective or less effective” in today’s economic climate.
Trouble is, many alternative investments have had lousy returns in 2022, too.
From January through early September, the price of gold declined about 7%. “Gold is supposed to offset inflation, but gold has done nothing” lately, said Savage. Real-estate investment trusts (REITS) which buy apartments and commercial buildings have lost roughly 15% of their value.
And the price of bitcoin — the biggest cryptocurrency by market capitalization — has dropped by nearly 60%. “Crypto is an alternative that’s going down with the whole [stock] market,” said Savage.
See: Why the 60/40 portfolio is a worthy strategy even though stocks and bonds are weak
But it’s important to view investing as a long-term proposition, money pros often say. That’s why growing numbers of them now recommend keeping a small portion of your investment holdings in alternatives.
“It makes much more sense to say: ‘I’m going to make tiny bets on a number of things. One or possibly 2% of your investment portfolio is probably a good number,” said Olson. That way, if the investment sours, you’ll only lose 1% or 2% of your portfolio. “That’s probably not going to derail your overall financial future,” he said.
Olson added that he’s heard some investors say they’re putting their entire life savings into an alternative investment. “That is a formula for disaster,” he said.
Questions to ask before investing
Savage is generally not a fan of alternative investments. “You have to ask yourself: ‘Who’s selling this to me? What are the real costs? And how are you going to get out when you want to sell?’” she said.
She calls them “the roach motel of investments” — easy to get into and almost impossible to get out. That’s because there’s no publicly traded market for many of them.
On the flip side, managers of privately traded alternative investments have more freedom to focus on long-term results because they needn’t focus on daily and quarterly results, as CEOs of publicly traded stocks are.
Knowing the risks and drawbacks
There is no getting around that alternative investments are riskier than traditional stocks, bonds, mutual funds and exchange-traded funds, though.
“They’re not subject to the same level of regulatory scrutiny and oversight that publicly traded investments are,” said Krueger. So, it can be hard to know much about who’s behind them, how they operate and how well (or poorly) they’ve performed.
“Just because you can access alternatives doesn’t mean you should,” said Krueger. Her advice: if you want to dip into alternative investments, first discuss the idea with a fiduciary financial adviser who represents your best interests and won’t pocket a commission from the companies whose products he recommends.
Beware of steep expenses, too. A writer on the Motley Fool investing site said 90% of private REITS, for example, charge “unreasonable commissions and fees” that go up to 12%.
Also see: Rich millennials say this is the best long-term investment
The fraud factor
Caution is the watchword when it comes to alternative investments.
The SEC charged one real estate and alternative investments company with fraudulently raising $13.5 million from more than 100 investors “in Ponzi-like fashion” promising to pay them returns of generally 10% a year.
Cryptocurrency scam losses totaled $700 million in the first half of 2022 and precious metals fraud cases have risen by 84% since 2019, according to the North American Securities Administrators Association (NASAA).
Arbitration panels of the Financial Industry Regulatory Authority received more than 400 investor complaints against REITs last year, The Wall Street Journal reported. Most of the complaints involved nontraded REITs — a popular alternative investment that’s not bought and sold on public exchanges, so does not need to comply with exchange rules about disclosing financial information.
NASAA has said it plans to crack down on nontraded REITS. It’s considering prohibiting people from putting more than 10% of their liquid net worth in a nontraded REIT.
Alternatives to alternatives
There may be alternatives to alternative investments worth considering.
Savage thinks people now looking for safe havens for their money with reasonable returns take advantage of short-dated Treasury bills and notes. They’ve been paying 4% or so.
Rising rates have also led some banks to offer 3% to 3.5% on 1- to 5-year certificates of deposit. In addition, there are income-producing stocks currently yielding roughly 5%.
Richard Eisenberg is the former senior web editor of the Money & Security and Work & Purpose channels of Next Avenue and former managing editor for the site. He is the author of “How to Avoid a Mid-Life Financial Crisis” and has been a personal finance editor at Money, Yahoo, Good Housekeeping, and CBS Moneywatch.
This article is reprinted by permission from NextAvenue.org, © 2022 Twin Cities Public Television, Inc. All rights reserved.
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