Have you invested money in the stock market only to experience a loss? Most people will invest in institutional products, because they’re familiar with them, or because it has been a recommendation from their advisor, or broker. These financial products, such as stocks, bonds, and mutual funds (just to name a few) may be ideal for some investors, but not all. And frankly speaking, most of these recommendations are directly related to a financial firm’s initiative to promote certain investment products. After all, most brokers’ income is commission-based.
When you’re investing in volatile markets, you have to understand that gains and losses are completely unpredictable. In a split second, you can encounter a rather devastating loss. You can also make great returns. But if you don’t know when to get out, it’s just a matter of time before something happens and you have to take a loss. It’s all cyclical. And although there are many market experts out there, unless they’re able to predict the future, their advice is just an assumption of behavior.
It’s crucial to understand all of your options, so you can make informed investment decisions that work for your retirement horizon and financial goals. Alternative investments have always been around and the right one can offer you an attractive risketurn ratio. However, not all investors understand alternative investments, or the benefits of diversifying their assets with these types of non-institutional products. And because they’re not usually offered by renowned investment firms, most people hesitate to consider these options.
Alternative investments can help offset portfolio risk and help you earn more money for the long-term. Below are some of the more common alternative investments available today along with their pros and cons:
Real Estate Investments
An investment in real estate is one that you shouldn’t jump into without careful consideration. It’s a long-term investment. With real estate, you’re investing a large chunk of your assets into a physical piece of property. You’re fully responsible for maintaining the property, repairs, paying taxes, finding good tenants and collecting rent. And if you plan to purchase multiple investment properties, you may need to hire a management company to help you out, which can quickly become an expensive expense.
Pros: The biggest advantage to buying investment properties is the amount of control the investor has. Direct investments in real estate, allow investors to take advantage of local real estate opportunities while gaining an additional source of monthly income through rent.
Cons: A big disadvantage to purchasing real estate as an investment, is the large amount of capital one must invest to buy just one property. For multiple properties, the capital investment is even larger. And real estate isn’t very liquid. If you’re strapped for cash and need to sell, you may have to take a loss. And then you’ll have to pay capital gains/loss taxes.
Real Estate Investment Trusts (REITs)
REITs allow you to invest in real estate without having to directly purchase a property. When investing in a REIT you can either choose an Equity REIT, which owns a portfolio of investment properties, or a Mortgage REIT, which provides mortgages to real estate investors. Companies who own, or finance income-producing real estate, sell shares of these properties to the public. These shares are traded on the stock exchange just like any other publicly traded stock.
REITs are required to pay dividends of at least 90% of earnings to their investors. And annual yields are usually between 0.25% and 18% — making this alternative investment an attractive option for many investors. However, be cautious of higher than average yields as this could be an indication of a highisk investment. REITs with good returns will average yields of around 5%.
Pros: An advantage of investing in a REIT is that it makes it easy for investors to diversify their portfolios with real estate investments, by buying one or more shares of these two types of REITs. Investing in a REIT allows the investor to choose specific sectors of the real estate market, such as shopping centers, apartment buildings, medical buildings, or commercial properties. REIT shares also pay dividends with yields higher than typical stock shares.
Cons: A disadvantage of investing in a REIT would be that the value of REIT shares often follow the trend of the rest of the stock market. This tends to somewhat negate the diversification benefits of investing in real estate. Additionally, the dividends earned on REIT shares are fully taxable. Dividends from ordinary corporations are taxed at a lower rate, so a portion of the higher yield from REIT shares can be canceled out by tax rules.
Master Limited Partnerships (MLPs)
Master Limited Partnerships are publicly listed securities traded like stocks, but taxed as partnerships — not to be confused with Limited Partnerships (LPs) which are not traded. An MLP usually has two partners. A general partner, who manages the everyday affairs of the MLP and a limited partner, (or group of limited partners) who invests into the MLP and earns interest/dividend income. MLPs allow investors to invest in real estate and commodities while earning returns between 6% and 8%.
MLPs can only legally hold real estate, natural resources, and commodities. And at least 90% of the MLP income must be from these qualifying sources.
Pros: The advantage of investing in an MLP is that it combines the tax benefits of an LP (limited partnerships do not pay taxes on profits. The money is only taxed when unit holders receive distributions.) with the liquidity of a publicly traded company.
Cons: While MLPs may offer investors an attractive balance of tax benefits and liquidity, there are also some disadvantages. Some of these may include, concentration risk, exposure to potential volatility, tax reporting complexity, fiscal policy and market risk. Additionally, MLPs may at times be illiquid due to fewer MLP trades (when compared to stocks and bonds).