Your Finances: What about 'alternative' investments?
If you work with an investment adviser, there's a decent chance that sometime during the last year you've had a conversation about "alternative investments."
There's also a decent chance you emerged from that conversation without understanding exactly what your adviser was talking about. Don't feel bad -- there's a lot of jargon surrounding this new trend in finance.
Strictly speaking, an alternative investment can mean anything that isn't a plain vanilla stock or bond, but now it represents a grab-bag category that can include everything from gold or currency to mutual funds that employ hedges, leverage, options, short-selling, derivatives and more.
This entire category is being heavily promoted to financial advisers, who are in turn pitching it to their clients, as a way of limiting portfolio risk -- and justifying the adviser's fees.
Should alternative investments get your money? Here are some points to ponder.
Not all alts are the same. Some, like absolute return funds, aim for low risks and steady returns. Others use leverage to actually increase risk and potential return. The latter may include funds that triple the return of the Standard & Poor's 500 stock index, for example. You wouldn't want to buy a fund like that if you were looking to de-risk your portfolio.
Beware the "this time it's different" argument. There's a lot of talk about the "new normal" swirling around alternative investments. But investors who buy into the idea that market fundamentals are changing tend to get burned when those markets regress to their mean.
Define your terms. If you don't understand a product, don't buy it.
Follow the money. In many cases, these funds are being sold because they are really expensive compared with plain vanilla mutual funds. "Some of these funds have low-risk, low-return profiles you would see in a bond fund," says Josh Charney, a Morningstar analyst, "but they charge an egregious amount for that risk profile."
Put them in their place. It may not hurt to have some kind of alternatives, such as commodities, in your portfolio for ballast, says Charney. Keep the allocation below 15 or 20 percent, and make sure you alter the rest of your portfolio to adjust for that. For example, if you load up on calm, steady alternatives that correlate to bond funds, you might hold fewer assets in bond funds.
Recognize that you might miss out. If you buy a triple-leveraged stock fund and the market tanks, you'll lose money twice as fast. But if you put a lot of money into a calm, hedgey risk-averse alternative fund and stocks take off like gangbusters, realize that you'll be left behind.