Investing in traditional assets like stocks and bonds is a well-established practice when saving for retirement. However, living in a time in which unprecedented events can occur with sometimes alarming frequency has caused many investors to question how safe and reliable traditional investments truly are. This has resulted in an increasing number of investors considering alternative investments. However, these alternatives are far from risk-free. This article explores both alternative and traditional investments with a view to helping you safely navigate today’s increasingly unpredictable world.
Traditional investments include stocks and bonds, which remain the cornerstone of most portfolios because they are widely accessible and supported by decades of market data and regulation.
Alternative investments, on the other hand, is a broad category referring to assets outside conventional markets. These can include commodities (such as gold, oil, and even agricultural products like wheat and coffee), art, investment-grade wine, as well as private equity, venture capital and hedge funds. If you would like a more in-depth list, please see our list of alternative investments.
The Case for Traditional Investments
- Liquidity: Traditional investments are highly liquid and are relatively easy to buy and sell. Stocks can be traded daily on exchanges, allowing investors to convert them into cash relatively quickly if needed.
- Valuation Clarity & Regulation: Traditional assets like stocks are bought and sold at universally accepted prices determined by active markets. The public markets where traditional investments are traded are also heavily regulated, which includes ensuring investors have access to accurate financial information which helps mitigate the risk of fraud.
- Income: Bonds and dividend-paying stocks can provide steady income. These assets can therefore create a cash flow generating foundation to investment portfolios.
- Lower Barriers to Entry: With the emergence of online brokerage platforms, today almost anyone can start investing with as little as a few dollars, making traditional assets highly inclusive and more accessible today than ever before.
Disadvantages of Traditional Investments
- Market Volatility: Public markets can swing dramatically based on economic news, interest rate changes, or global events. Even well-diversified portfolios can experience losses during market downturns.
- Limited Control: Investors generally cannot influence how public companies are run or how markets behave.
- Lower Potential Returns: While generally safer, traditional investments may not deliver the same high returns that riskier alternative assets can offer.
- Research & Monitoring: Investing in individual stocks requires researching factors such as company earnings and bonds require investors to evaluate the issuer’s ability to repay (credit ratings, financial stability, default history) all of which can be time-consuming. Mutual funds can alleviate this for those who prefer a more hands-off approach, but investing in these also means investors have even less control as they cannot select the individual stocks or bonds the fund invests in.
The Appeal of Alternative Investments
- Portfolio Diversification: Alternative assets often have low correlation with traditional markets. This means when stock markets fall, certain alternative assets (like gold or famous artwork) may hold their value or even rise, helping balance overall portfolio risk.
- Potential for Higher Returns: Some alternative investments, especially private equity and venture capital, can deliver higher returns by taking advantage of opportunities beyond public markets (although performance varies widely).
- Inflation Protection: Tangible assets like commodities tend to rise in value when inflation increases, making them strong hedges against a weakening currency.
- Unique Opportunities: Alternative assets can offer access to niche markets, innovation, and global growth opportunities that traditional investments can’t always provide.
Disadvantages of Alternative Investments
- Limited Liquidity: Many alternative assets are not as easy to sell as stocks or bonds, and investment in private equity in particular can lock-up capital for yeas. Therefore, investors often cannot easily sell and convert their investments into cash if personal needs change.
- High Risk & Volatility: The potential for higher rewards comes with higher risks. Startups can fail, and even though prices may be uncorrelated with traditional markets, the prices of commodities can still fluctuate wildly.
- Complexity: Understanding and managing alternative assets can require specialized knowledge. For example, futures contracts in the case of commodities can involve understanding tick increments, tick values, and if the futures contract is held until expiry can even require the investor to actually deliver the physical commodities specified in the contract on a certain date.
- Valuation Uncertainty: As alternative assets are not typically traded on public exchanges at universally accepted market prices like stocks are, precise valuations can be difficult to determine with certainty.
Conclusion
The world of investing has become much more than just stocks and bonds. As financial markets evolve, alternative assets are gaining ground as powerful tools for diversification. However, these distinctive assets also come with their own distinctive risks and careful due diligence is essential. Ultimately, the most successful investors will be those who can balance both reward and risk: leveraging the advantages of traditional assets with the growth potential of alternatives. By understanding the strengths and weaknesses of each, investors can design a portfolio that not only weathers market volatility, but also positions their portfolio for long-term financial success.
Disclaimer: The purpose of this website is education and financial journalism. It is not a recommendation or personalized financial advice. Your personal circumstances have not been taken into account, and this website is not a substitute for consulting a qualified financial advisor. All images are for illustrative purposes only. Past performance is not indicative of future returns.