Addings ALTS to your Portfolio
By Brad Thomason CPA
2/18/2015
Ready to make the move and start adding alternative investments to your portfolio? Great. Here are a couple of ways to approach it.
First of all, what kind of investor are you? Are you building a nest egg which you don’t expect to need until sometime out in the future? Or are you approaching (or already in) retirement and need to turn what you’ve saved back into an ongoing stream of income?
If you are in growth mode (and this would go for individuals building a nest egg as well as professional managers who stay in growth mode all the time) then the situation you are probably facing is one of balancing some of your allocations against capital that you currently have in stocks. We like to see a handful of different allocations at the asset class level, because we think it’s simply bad practice not to have some diversification. So no matter how much you love stocks, we think you still need some exposure elsewhere.
Growth investors looking to diversify stock holdings usually focus on return as the primary factor. Rental real estate deals and life settlement contracts are a couple of possibilities that often fall in the higher end of the range for rates of return. Investors in these kinds of assets often earn from 7% or 8% on up into the mid teens, in some cases.
Investors who have already finished saving and are looking to transition to income, often like the idea of getting away from stocks altogether. The possibility of a large downward fluctuation is more than they want to worry about; and the damage which occurs when retirees have to pull out money for living expenses in the midst of a downturn is more than they want to be subject to. For investors of this type, a two-step move is common.
First, allocations to the kinds of assets mentioned above might be considered if there is a need for higher-yielding assets to be in the portfolio. But with the rest of the portfolio they consider things which have slightly lower return prospects, but much more robust risk offsets or guarantee features. Insurance companies often have products which are well suited to these needs. Fixed Indexed Annuities, for instance, offer retirees a shot at sizeable gains in years when stocks boom, but they do so inside of a larger framework which guarantees that stock losses won’t lead to a capital loss in their account. These contracts essentially give access to the good without exposure to the bad. Mutual Fund companies can’t make similar promises, because in the US investment companies can’t make financial guarantees (only banks and insurance companies can).
So a retiree might look at some exposure in real estate or life settlements to target higher returns, and consider FIAs or perhaps asset-backed long term care insurance for their safer-money allocations. Working together, these options could create a portfolio which has lower exposure to investment risk, without settling for the anemic yields that bonds, CDs and the other traditional safe options pay right now.
Because of the general need to diversify, investors of all types should look at what’s available from the alternative arena. What you select, and how much you allocate away from stocks and bonds, will vary based on where you are in your financial life cycle, and how close you are to the point that your assets need to bear the job of paying for the life you want to live.