The Introduction Series #1: Wall Street vs. Alternative Investments
Part 1 in a Series by Denis Shapiro
If you're like most investors, you've built your portfolio on traditional assets like stocks, bonds, mutual funds, certificates of deposit (CDs), and exchange-traded funds (ETFs). Purchasing these investments is usually referred to as "investing on Wall Street" because all of the instruments (with the exception of CDs) are traded on the stock market.
Financial advisors usually prefer to use traditional Wall Street assets to build their clients' portfolios because they are well-known and, as a result, have developed a certain level of inherent trust over many decades. Today, the majority of the United States holds their wealth and retirement plans in traditional assets like these. In fact, the long-standing "gold standard" has been creating a portfolio that consists of a portion of stocks, which serve as a growth component, and a portion of bonds, which provide income and downside protection.
As a client ages, the portfolios are often rebalanced to increase safety through more bond exposure and fewer stock holdings. A traditional rule of thumb in the industry has been to match the percentage of a portfolio that is invested in bonds to a client's age:
Example of a portfolio for someone at the age of 60:
Example of a portfolio of someone at the age of 70:
These traditional assets are usually presented as safe investments by the financial advising community, since advisors can find multiple analysts' reports that support each position in their portfolio that represent three general recommendations: buy, sell, or hold.
This allows an advisor to easily justify their position to their clients, while also providing a convenient scapegoat if their position underperforms. There is also the added incentive of compensation, as certain Wall Street investment vehicles, like mutual funds, are loaded with fees that allow financial advisors to benefit from how they allocate their clients' portfolios.
Like all investments, traditional Wall Street instruments have their pros and cons.
The Pros
Wall street investments are considered very liquid since they can be traded at any time day or night, allowing you to convert back to cash in a relatively short period of time.
In addition, the emergence of index funds allows individual investors to build a diversified portfolio with one click of their mouse for a relatively low fee. The growing popularity of index funds has caused a race to the bottom scenario among index fund operators, with certain funds offering 0% expense ratios-allowing you to own a slice of the market with no costs above your initial investment.
Traditional assets are also usually heavily regulated and audited, and publicly traded companies are required to report their performance on a quarterly basis-all of which reduces the likelihood of fraud. In addition, the analyst community is large and active, and you can readily access their opinions any time of day or night on your smartphone, laptop, radio, newspaper, or TV to see what's happening in the market. Essentially, if you never want to network with other investors, you can still invest effectively with the research that is instantly available out there.
The Cons
The liquidity of Wall Street assets is subject to wild price moves that wreak havoc on an investor's emotions. Price fluctuations in Wall Street assets are usually referred to as volatility. With the increase in automated trading that's designed to make transactions instantly based on a series of formulas (algorithms), volatility has taken on a whole new meaning on Wall Street.
That's one reason why Wall Street tends to make "geniuses" out of your friends and neighbors during the good times. In 2020, the wild success stories were Bitcoin and Tesla. In 2021, it's been GameStop and AMC. The reason behind each windfall is different, but the euphoria remains the same-until the market changes course. With the increase in volatility, significant downturns can happen overnight, which turns yesterday's geniuses into today's disgruntled investors.
If you choose to follow your stock market investments closely, there's no escaping the oversupply of information out there, and it can overwhelm you into a bad decision. Too much information is sometimes not a good thing-and you can't always trust what you hear. Many times, a brokerage company will promote an Initial Public Offering (when a stock goes public for the first time) and then be expected to provide an unbiased analyst report a short time later. Many times, there are blatant conflicts of interest behind the scenes that an investor is never aware of.
Finally, when a person decides to invest, they often leave the entire process in the hands of an "expert" financial advisor. This mentality stops the learning process for them, and they end up having no idea what's actually going on. They don't know why their assets are underperforming, and when they get fed up, they jump to another "expert advisor." Keeping even a limited portion of your portfolio in your own hands and following along will help you continue to grow as an investor and give you knowledge that you can build on.
A Look at the Alternatives
This is where alternative investments come into the picture. Alternative investments are investments that fall outside of the traditional Wall Street bucket of options.
Some of the more common alternative assets include:
- Commodities
- Real Estate
- Private Equity
- Venture Capital
- Hedge Funds
- ATMs
- Life Insurance Policies
- Collectibles
- Foreign Currencies
- Cryptocurrency
And that is just the tip of the iceberg, as each category can be broken down further. For example, real estate can be broken down into:
- Apartment buildings
- Mobile home parks
- Self-storage
- Office buildings
- Industrial space
- Retail
Because Wall Street is not involved, and the investor can't buy and sell at the click of a mouse, most alternative investments are relatively illiquid and less volatile compared to traditional assets-yet they often offer similar projected returns as what you would find on the stock market.
But alternative investments remain a mystery for most investors, even though we live in a world where information is readily available, on demand 24/7/365. In this article series, I'll take a deep dive into alternative investments to reveal more about why I think they're a valuable part of any investor's strategy and how you can adjust your investment portfolio to include this often-overlooked asset class.
Disclaimer: The information presented in this article is for informational purposes only and does not constitute professional financial or investment advice. The author does not make any guarantees or promises as to the results that may be obtained from it. You should never make any investment decision without first consulting with your own financial advisor and conducting your own research and due diligence. Even though, the author has made reasonable efforts to ensure that the contents of this article were correct at press time. The author disclaims all liability in the event that any information, commentary, analysis, opinions, advice and/or recommendations contained in this article results in any investment or other losses. Your use of the information in this article is at your own risk.
Comments