Many people invest in the stock market and try to become diversified by buying stocks in different companies and industries. During those proverbial black swan events, they often find that all of these investments decrease in accordance with one another and that they are more strongly correlated to each other than people might otherwise think. For true diversification, it may be time to consider investing in alternative investments.
What are Alternative Investments?
The term “alternative investments” is a bit of a vague term but includes items that can yield investment returns that are not commonly traded (ex. Not stocks or bonds) and which offer some real diversification away from these investment classes.
A master limited partnership (MLP) represents an ownership percentage of an entity that owns some joint research. Many MLPs operate in the energy sector and own oil pipelines or fields. MLPs may be correlated with the underlying commodity of oil or may operate independently by earning a service rate on oil passing through a pipeline.
MLPs have some tax-deferred characteristics as you are only taxed on distributions that exceed your basis in the MLP. They offer exposure to a resource that very few can own on their own that is often not correlated with the larger stock market.
Real Estate and REITs
Real estate is an alternative to investing in stocks and equities and are not highly correlated to equities and bonds. Further, if you own real estate outright you can profit on the appreciation of movements in local areas as real estate is always local. You can, therefore, use your knowledge of a local area, as well as any skills you have in renovating, to earn an outsized return on a real estate investment.
If you don’t have the cash to buy a property or don’t want to manage the real estate yourself you can buy an interest in a real estate investment trust (REIT). An REIT allows you to own a share of a company that owns and operates real estate and provides you with a more diversified set of real estate holdings.
Artwork and Other Collectibles
Artworks are a true alternative investment that anyone can buy and hope to see appreciate over time. Art is subjective and may require real skill to identify early enough to earn a solid return on investment, but offers some real opportunity to earn significant amounts on.
Collectibles are similar to artwork. Some appreciate invalid while others degrade in value. Since collectibles don’t represent a share of earnings like equities do, collectors are often looking for an overall appreciation in price in conjunction with trends or scarcity. It takes a fine eye to identify undervalued collectibles to invest in but the return can be significant. Gains on artwork and collectibles are taxed at 28%, significantly higher than the 15% on capital gains rate on equities.
Alternative investments provide much-needed diversification to investors. Owning a portion of your portfolio in these alternative investments may lower risk and accelerate earnings, though additional diligence will be needed when choosing these investments.