Should I consider expanding my investing beyond stocks and bonds?
For most time periods, some combination of stocks and bonds has worked fairly well. In fact, only 3% of the time are stocks and bonds both down in the same year. Meaning 2022, looks like the first time since the 1930’s that we will have that phenomenon take place. So generally speaking, most financial professionals are not abandoning traditional stocks and bonds, but there are several alternative class investments that clients may want to consider, as a tool for further diversification or a hedge against unique market behavior like that of 2022. In this article, we will explore a variety of alternatives that both advisors and investors may consider using in their portfolios for either short or long-term time-horizon.
Private Real Estate
Although using publicly traded real estate (REIT’s) is common and provides some level of diversification, private real estate has a much lower correlation to stocks and bonds. The main reason for this is that real estate markets react to many economic conditions as all markets do, so those reactions have to be valued daily or even on a minute-by-minute basis with ETF’s. Because of this, publicly traded REIT’s end up moving very similarly to stocks that are reacting to a constant flow of new economic data and thinking. Private real estate appraisals are taken only once per quarter or as infrequently as once a year, so the constant speculation and head fake that REIT’s react to is removed in the private real estate funds and therefore offers a much less volatile investment vehicle that provides some true diversification to the stock and bond markets.
These are bonds, with maturities that are usually five years or less, issued by large banks. The moving parts and terms can vary quite a bit, but generally speaking there is some type of downside protection and the return is much more defined and predictable. Banks build these notes using options and zero-coupon bonds, to be able to offer attractive returns to investors, while taking on minimal risk themselves. In a year like 2022, where traditional stocks and bonds are suffering mostly double-digit losses, both downside protection and any return that is positive, have made these notes attractive to investors, this year. Just like with any other investment or asset class, research is necessary and structured notes are no exception as some can entail a high level of risk or offer minimal returns and value. Doing research and working with an advisor that has access to and knowledge of structured notes should offer you lots of value and a well-diversified portfolio. Finding quality structured notes that focus on income, will often outperform most bonds and bond mutual funds. One downside to notes is that although they can usually be sold at any time, you are much more likely to lose out on some principal if, in fact, you don’t hold it to maturity, versus holding to the stated maturity date of the note. Because of their liquidity, it’s still important to maintain a balanced portfolio of traditional stocks, bonds, and money markets in addition to structured notes.
Gold has always been the go-to metal when seeking a hedge against inflation or the falling value of the dollar. Silver is also a common choice, although silver does have more industrial uses and technically gold and silver are commodities, they are usually put in a separate class and are purchased and invested in commonly as either a store of value or on speculation of near-term increases. People like gold and silver because of their proven staying power. Gold and silver are referenced in the Bible as a form of money and the desired investment, so people figure if they have a 6,000-year track record as an investment, then those precious metals will never become worthless. Casual investors many times make the mistake of thinking that gold and silver are not volatile and are safer than stocks, but precious metals can in fact fall in value and stay down for long periods of time. Gold was trading at $667 an ounce in September 1980 and it wasn’t until August 2007 that gold exceeded that level. So, you would have waited almost 27 years, just to break even. Stocks have rarely been negative over a 5-year span and have never been negative for any 14-year or greater span.
Commodities are physical assets but can be traded via mutual funds, ETF’s, or options. These assets are generalized into soft commodities, which are food and livestock, and hard commodities that need to be drilled or mined for, like oil, coal, aluminum, and gas. Much like precious metals, commodities have appeal because they are tangible and have longevity in society. Also, like metals, they can be perceived as “safe” but can fall fast and stay down for several years. This year is an example of commodities being a good play and are mostly up and up strong in a year the stock and bond markets are down. So non-correlation is a benefit to investing in commodities, but because stocks are up nearly ¾ of years, commodities are not usually desirable to buy and hold long term.
Although bitcoin has been around for over a decade, it and others like cryptocurrencies have been accepted into the mainstream of investing within the last few years. Just as crypto was starting to be more accepted, FTX (a major crypto exchange) just recently declared bankruptcy and is embroiled in a fraud scandal that is still unfolding, which has resulted in a loss of traction for the crypto world. Cryptocurrencies can be appealing because of their low correlation to the market and lack of dependence on the ebbs and flow of fiat currencies as well as the ease of quickly making transactions in foreign countries. However, the fact that still, such a small percentage of the population has crypto, makes it difficult to view it as a reliable and battle-tested currency. Other investors view crypto as a store of value or “digital gold” but because it cannot be physically seen and is often confusing to some investors, it faces an uphill battle as it aims for wide acceptance.
So, what is the answer?
Although we covered most of the common alternatives to stocks and bonds, it is not an exhaustive list. Collectibles, rare cars, currencies, options trading, physical real estate, and timeshares are just some of the other alternatives that investors may also consider. We have all heard success stories and big gains in these various alternative asset classes, but none of them is a sure thing and should not be used in place of stocks and bonds anytime soon. There are several variables to weigh with adding alternatives to your investment portfolio, but they are good to consider as a way to diversify or add value under certain circumstances. As a general rule, not going above 5% of your portfolio in any of these classes is usually a good approach to maintain a healthy level of risk, while still achieving some extra diversification. Be careful about attempting to over-diversify into alternatives. An example would be selecting 2-3 alternative assets that make sense at a specific time for a specific reason, keeping investors from taking on more risk than they intend. At Whitaker Myers Wealth Managers we feel that well-managed stock and bond funds should be a core component of most investors’ portfolios, but we do not want clients to miss out on sensible opportunities that could add value to their portfolios, so we will do our homework, aiming for the right time to utilize various alternative investments. In short, you should use alternatives, but they need to be the right ones at the right times, with sensible percentages, which can be a challenging balance to achieve. This is why it’s important that you talk to your financial advisor about these options and what makes sense for you.
STOCKS, BONDS, AND BEYOND FOR INVESTING
December 15, 2022
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