You’ve heard that a diverse investment portfolio is key to reaching your financial goals. But what makes a portfolio diverse? Can bonds and alternative investments help you intentionally diversify? Let’s find out.
What Does It Mean to Have a Diverse Portfolio?
You’ve probably heard the saying, "don't put all of your eggs in one basket," Those wise words ring true regarding your investment portfolio.
Imagine you put everything you have into an investment supposedly ‘guaranteed’ to succeed. But then a recession hits, and a once profitable investment is gone in a blink of an eye. A diversified portfolio could’ve helped soften that blow.
A diverse portfolio contains various investment types, which helps lower your risk of extreme loss. Stocks, mutual funds, exchange-traded funds (ETFs), certificates of deposit (CDs), annuities, and cryptocurrencies are examples of different investment types you can explore.
All investments carry some level of risk, but the trick is finding the "sweet spot" of risk and diversity. A diverse portfolio will help you retain more of your assets in the event of a steep decrease in one of your investment areas.
Understanding Your Risk Tolerance
Before creating a robust portfolio, you need to understand your risk tolerance. This is defined as the amount of risk and market volatility you are comfortable taking as an investor.
Risk tolerance is not to be confused with "risk capacity," which is the amount of risk you must take to reach your financial goals. For example, if your goal is to become a millionaire investor, you likely will have to invest in riskier things than just bonds.
Risk tolerance varies greatly depending on age, income, and financial goals. A 26-year-old working at a high-paying tech company will accept more risk in their investments than a 55-year-old nearing retirement.
To understand your risk tolerance, you need a clear idea of your investment and financial goals. What age do you want to retire? Do you have debt that needs to be paid off? Are you interested in buying a house in the next few years? How does the idea of “risk” make you feel about finances? These are all questions you need to consider before diversifying your portfolio.
What is Considered an Alternative Investment?
An alternative investment is a financial asset that doesn’t fall into one of the conventional investment categories like stocks or bonds. They are incredibly diverse, and the accessibility and structure of these investments vary significantly between asset types. Here are a few examples of popular alternative investments:
- Commodities: These are physical materials and natural resources that are traded, such as gold, natural gas, corn, or coffee. Commodities can be tangible objects like gold, or you can own shares/stocks of a company that sells commodities. If you have shares in a commodity company, you can receive dividends when it peaks in price, but if you have physical commodities, you can only profit if you sell at the right time.
- Collectibles: If you have old baseball cards in your basement, it may be time to knock the dust off and see what they're worth! Collectibles are items that people hold at a high value, and the options are unlimited. Beanie babies, jewelry, art, or vintage cars are all great examples because they can gain significant value over time.
- Real Estate: Real estate is any land or property in your possession that you hope will increase in value over time or that you can source income from immediately, such as a rental home or apartment building. If you want to avoid becoming a landlord, you can also invest in a real estate investment trust (REIT) which is publicly traded and potentially more liquid in terms of assets.
- Private Equity: Private equity is on the pricier end of alternative investments. This requires a significant investment in a privately held company by yourself or as part of a group of other investors. A more accessible way to private equities is through hedges, mutual funds, or crowdfunding.
When deciding on an alternative investment strategy, consider any potential risks and the time you need to hold the investment. For example, investing in real estate would be a higher risk and require a longer time horizon than investing in collectibles.
Do People Still Invest in Bonds?
Bonds are still relevant and popular in today’s day and age. Think of a bond as an "IOU." As the investor, you are lending money for a particular time. The person you are lending to will pay you a specific interest rate during the bond's duration in addition to repaying the principal.
Investors continue to purchase bonds because they’re a predictable income stream—AKA, they’re a relatively safe, lower-risk investment option when purchasing an investment grade bond! In addition, if the requester holds the bond for the entire duration of the agreement, the benefit is twofold:
- You’re getting your investment back (which isn’t always the case with investing!)
- You'll also have gained capital during the duration of the investment.
Bonds can round out a diversified portfolio because, unlike stocks, when the market is unstable, bonds tend to provide a fixed-income “cushion” that investors can rely on. You probably won’t become a billionaire from investing in bonds alone, but they complement a diverse portfolio nicely.
Your Advisor Can Help You Find the Right Balance
Investing in various bonds and alternative investments can be an excellent way to diversify your portfolio. Work with your advisor, who is well adverse in this area and will help you find the correct portfolio balance that is both diverse and comparable to your spending habits and time horizon.
If you’d like to learn more about diversifying your portfolio with bonds and alternative investments, get in touch with our team at Pro Wealth.
This information does not constitute an offer to sell or a solicitation of an offer to buy any securities or investment strategy and is intended for informational purposes only. Investments are subject to market risk, including the loss of principal, and the investment strategies described may not be suitable for all investors. Equities are subject to market risk meaning that stock prices, in general, may decline over short or extended periods. The information contained does not take into account any investor's specific individual investment objectives, particular needs, or financial situation. Nothing in this material constitutes investment, legal, accounting, or tax advice, or a representation that any investment or strategy is suitable or appropriate.