When discussing asset allocation, most folks think of the mixture of stocks, bonds, and cash in their portfolio. While this is not necessarily wrong, asset allocation is more complicated than simply picking the appropriate pie-chart or Morningstar style box.
As a Financial Advisor, I spend much of my time managing the risk associated with a client’s investments. An important part of minimizing that risk in a portfolio is to find asset classes with a low correlation to one another. In other words, if two different investments always move in the same direction then we have not done anything to decrease risk in the portfolio by owning both. The only thing we gain is a false sense of diversification by investing in more than one asset.
One way to effectively lower the risk of your overall portfolio is by using alternative investments. “Alternatives” are simply defined as assets that don’t fall into the standard categories of stocks, bonds, or cash. The reason we add alternatives to an account is that their returns have little or no correlation to those of stocks or bonds.
The most commonly used alternative investments include commodities (oil, gold, silver) and real estate. More complicated alternatives could include hedge funds, managed futures, foreign currencies etc.
Properly allocating a portion of one’s portfolio to alternative strategies could help “smooth out the bumps” of continued volatility in the stock market. They can also help immunize a bond portfolio from an inevitable rise in interest rates.
In the past, alternative investments were reserved more for institutional or highly sophisticated investors. Lately, they are becoming more available to the average investor through more traditional means such as mutual funds and exchange traded funds (ETFs).
While I feel that alternatives can help reduce a clients overall risk exposure, every investor’s situation is different. Careful consideration should be used in deciding whether they are an appropriate addition to your portfolio.
Securities and investment advisory services offered through Financial Network Investment Corporation, member SIPC - Founders Federal Credit Union, Founders Financial Group, LLC and Founders Insurance Services are not affiliated with Financial Network Investment Corporation. Financial Network Registered Sales Branches are located at 607 N. Main Street, Lancaster, SC 29720; 1290 Old Springdale Road, Rock Hill, SC 29730; 100 Springcrest Drive, Fort Mill, SC 29715; 1307 Boiling Springs Road, Spartanburg, SC 29303.
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This article was published in the Founders FCU's Open Exchange Newsletter (July 2011). It was written by David Tolson, Financial Consultant with Founders Investment Services Team.