Alternative investments can be a great addition to your portfolio if you want to diversify with high-performance investments. Let’s explore diversification, strategies to consider, and how alternative investments can fit into your portfolio.
What’s an alternative investment?
Alternative investments are financial assets that don’t fall into the traditional investment categories like stocks, bonds, or cash. Some of the most common types of alternative investments include:
- Real Estate: This is an asset class that has a little something for everyone. If you own a home, you’ve already invested in real estate! To get further involved in real estate, you can invest in single-family home flips and renovations, multifamily buildings like apartments or condos, or domestic or foreign active farm properties. (and more!)
- Hedge funds: These are private, actively managed investment pools similar to mutual funds or exchange-traded funds, but more flexible.
- Private Equity: This includes investing in privately-held companies like venture capital, leveraged buyouts, or growth equity.
- Commodities and Natural Resources: Similar to a real estate holding, investing in natural resources like farmland requires a completely different buying and holding structure than real estate.
- Collectibles: Those Beanie Babies gathering dust in your basement? Those are considered alternative investments! Any valuable tangible object with the right audience can be considered an alternative, such as comic books, baseball cards, or vinyls.
Alternative investments can be a great way to diversify your portfolio. Since they are a limited part of the market and not linked to the stock market, the impact of market volatility is typically lower, with a potential for higher returns.
What does it mean to diversify my portfolio?
Diversification is an investment technique that allocates capital across a variety of investments and industries with the goal of increasing returns and decreasing risk. Simply put, diversification means investing in a variety of different investment types and asset classes.
A well-diversified portfolio has a mix of stocks, bonds, and alternative investments. You’ve likely heard the saying, “don’t put all your eggs in one basket,” which directly relates to portfolio diversification. Imagine if you put all of your hard-earned money into one promising investment that unexpectedly went sour. Then what?
Even the “most stable” investment can fail, so diversification helps spread risk and reduces the impact of a single investment’s bad performance. In a diversified portfolio, if one investment performs poorly, it can often be offset by the other investments.
3 Strategies to Diversify Your Portfolio
There are 3 main strategies that investors should consider when looking to diversify their portfolios:
- Individual Asset Diversification: This strategy focuses on investing in multiple assets within the same asset class. An example would be buying the market index, like the S&P 500, and investing in various high- and low-risk stocks.
- International Market Diversification: Another diversification strategy is to ditch domestic options and look abroad. This can be a great option if the stock market is performing poorly in the US and vice versa. There are excellent international stock options that can mitigate the risk to your portfolio in a time of economic downturn.
- Asset Class Diversification: This strategy focuses on diversifying across asset classes, which can be a mix of conventional and alternative investments. Alternatives are an excellent complement to a traditional-leaning portfolio and can be particularly advantageous in diversification efforts due to their lower volatility and high return potential.
Before you diversify your portfolio, think about 3 things
There are hundreds of different investment types and asset classes to choose from, so how do you pick? Investors looking to diversify should consider 3 main things when evaluating investments:
- Time horizon and liquidity: Time horizon refers to the amount of time an investor can expect to hold an investment, which can vary drastically depending on the investment type. Traditional investments like stocks and bonds are considered fully liquid because they do not have set time horizons. Alternative investments, on the other hand, tend to be illiquid, with many having longer time horizons. A well-diversified portfolio balances time horizons and liquidity so investors aren’t “locked in” to a specific investment type.
- Markets and industries: A diversified portfolio holds investments from multiple industries and markets. This means you should consider both private and publicly traded investments. When investing in private companies, it’s best to consider companies in industries that complement each other.
- Level of risk: One of the most important areas of investing is risk. The level of risk you’re willing to take on will dramatically affect potential returns and investments available to you. People often think alternative investments are riskier than traditional ones, but that’s not always true. Risk is present in all investment types, and because alternatives cover so many different types of investments, it’s not fair to label the entire category as high risk.
Are alternative investments the key to diversifying your portfolio?
They could be! It’s a common misconception that alternative investments are only for the ultra-wealthy. At Hedgehog Investments, we are making alternative investments more accessible than ever before!
As you consider how to diversify your portfolio best, we always recommend consulting a professional. If you need recommendations on financial professionals or are interested in Hedgehog’s alternative investment model, get in touch with our team.
*While a second mortgage is a home equity loan, it is technically only one type of home equity loan. For more information it’s best to talk to your lending institution of choice to get more details about the products that they offer.
This material is intended for informational purposes only and should not be construed as legal or tax advice. Information here is not intended to replace the advice of your investment advisor or financial advisor. This information is not an offer or a solicitation to buy or sell securities. This information may have been compiled from third-party sources and is believed to be reliable. All investing involves risk, including the loss of principal.