Alternative investments are a hot topic in the investment world and it is important that investors understand what they are and the multiple options that are available. Traditionally, an investment is considered either stocks, bonds or cash but alternative investments include private equity, hedge funds, managed futures, real estates, commodities and derivatives contracts. Alternative investment is a broad term and includes tangible assets such as precious metals, art, energy investments, etc.
Since alternative investments include more investments avenues than traditional investments options, they are a prime option to diversify an accredited investor’s portfolio. Diversifying one’s portfolio can potentially reduce risk and enhance gains.
Traditionally, investors are told a “60/40” allocation to stocks and bonds is sufficient to provide investors with the returns and diversification they need to achieve their goals. However, in today’s market this may no longer be enough to have a stable financial portfolio. Alternative investments have the ability to lower risk and increase returns because they can help mitigate the effects of market volatility.
Today, investors have broader access to nontraditional investment options than they have ever before. Accredited investors are reported to have tripled the allocation of alternative investments in their portfolios over the past 20 years and as investors increase their need of diversifying, this is expected to rise.
Novice investors or ones that are playing catch up with their retirement might not be as interested in alternatives. These investors need to focus on saving their money and setting up a simple portfolio that basically runs on its own. However, when your net worth begins to grow the need for alternative investments increases as well.
It is important to remember that alternatives are not meant to replace stocks and bonds, but simply to enhance your portfolio. Some investors do have all their eggs in the alternative basket and invest strictly in energy or hedge funds. But the average investor should have a mix of traditional and nontraditional investments to build a stable and long-term portfolio.
With any investment it is key to know what and where you are sending your money to. If you are investing in alternatives, you need to run due diligence and understand the fees, long-term performance and the return associated with the investment. Although alternatives may include more risk, they are there to keep your portfolio secure if your traditional investments, like stocks or bonds, experience volatility. A balanced and diversified portfolio sets you and your family up for financial success.
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