All About Alternative Investments
Alternative investments are receiving more attention in the press with the low interest rate environment and recent volatility in the stock market. However, alternative investments have been around for decades. What are alternative investments and why should you consider them in your portfolio?
What are Alternative Investments?
Investments are usually classified into two types of asset classes: stocks and bonds. For years, investors have combined these two asset classes in different ways to achieve different risk/return profiles. I like to think of alternatives as anything but regular stocks and bonds. The chart below outlines the basic investment universe.
The table below clarifies what these investments are and then gives some concrete examples. If you are unfamiliar with some of the terms used, we will cover them in our next alternatives blog post.
Why Invest in Alternative Investments?
There are many ways alternatives can add value to your portfolio. Diversification is one of the biggest value drivers for alternatives. These investments offer different risk, return, and correlation characteristics compared to stocks and bonds. The key to diversification is having low correlation between investments. A mix of stocks, bonds, and alternatives, when combined correctly, may offer similar returns to traditional stock and bond portfolios with a reduction in risk, or, put differently, potentially higher returns for the same amount of risk. This is illustrated quite effectively in the chart below:
Diversification compared to concentrated portfolios is like ordering the flight of beer tasters at a brewery instead of a pint. Yes they are smaller, but you get to try more options to find what you like. Please stay tuned as there will be more posts that dive deeper into the characteristics of this asset class and how Colorado Financial Management uses alternative investments in clients’ portfolios.