How to Invest In Alternatives

Posted on January 13, 2014 at 2:14 PM PST by

Spend a few hours on trading websites and you’re likely to run into a lot of advice regarding “alternative” investments.

Much of the talk will be about investing in gold, both pro and con, but nearly anything that’s not a stock or a bond could be lumped into this category, even artwork and jewelry if you stretch the idea far enough.

What all of the discussions have in common is the notion that you need some kind of counterbalance to traditional investment vehicles. Typically, the idea is to “hide out” when markets get rough or to hedge your bets.

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Should you buy alternative investments? Yes, some, but make sure that you keep things within reasonable boundaries in terms of your personal taste for risk.

Here are some guidelines for investing in alternatives for retirement:

1. Understand volatility

“Volatility” is how much a given investment rises and fall over a set period of time. Fixed-income investments are less volatile, normally, than blue-chip stocks. Small-cap stocks are more volatile than big consumer stocks. Precious metals can be a roller coaster, as well as emerging market stocks and foreign bonds.

Your reaction to that volatility is what matters. That’s why it’s important to maintain a strong sense of how much up and down you can stomach and, thus, how many high-volatility investments you should own.

2. Get a grip on liquidity

A stock or bond is “liquid” if you can easily buy or sell it during normal trading hours. As you can imagine, a major U.S. corporation has many institutional buyers and and sellers. Meanwhile, a tiny “micro-cap” stock might have a dozen or fewer at any given moment.

Liquidity directly affects your ability to enter and exit positions, so be aware of how many other investors are involved in any given investment you may consider.

3. Diversify

It’s extremely hard to value companies. People who do it for a living get it wrong on a regular basis. Big money managers diminish this risk by putting their eggs in many baskets.

As a retail investor, this used to be hard. Then along can exchange-traded funds (ETFs). As a result, you can now diversify your investments even in less traditional asset classes by owning an ETF of the sector or asset itself.

4. Know what you own

What’s under the hood? Owning an ETF is not a free pass to avoid your investing homework. Read the ETF prospectus and study the performance of the fund relative to the benchmark it purports to track.

As with any fund investment, a verifiable track record is a reassuring sign, but make sure that the fund hasn’t changed its mission before buying.

5. Rebalance, always

The principle of rebalancing still applies. As any given asset class outperforms, take gains and use the proceeds to buy back into those that lag.

You can use alternatives to improve your portfolio’s long-term performance. Just keep the weightings reasonable and absolutely avoid “all in” bets that amount to little more than market timing.