Welcome to NerdWallet’s Smart Money podcast, where we answer your real-world money questions. In this episode: Discover how alternative investments could help you diversify your portfolio.
Have you ever wondered about the potential of alternative investments in your financial portfolio? NerdWallet’s Andy Rosen sits down with certified financial planner James Lee to uncover the world of untraditional investments, including real estate, commodities, cryptocurrency and collectibles. They discuss a recent survey indicating a shift in financial advisors’ perspectives toward alternative investments and unpack the nuances of speculative investing. They also discuss guidelines for incorporating riskier investments into your overall investment portfolio and explain the key differences between investing and speculation.
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Sean Pyles: Got any baseball cards you’re hanging on to? How about Beanie Babies? Remember them? Or maybe you’re dabbling in real estate or you’ve got a massive art collection waiting for appraisal. All of these are considered “alternative investments,” and they all have their unique mix of potential risk and reward.
James Lee: Certain alternative investment classes can zig when the traditional asset class zags. And that can provide some diversification benefit to a portfolio, especially in times when traditional asset classes are volatile and moving downward.
Sean Pyles: Welcome to NerdWallet’s Smart Money podcast. I’m Sean Pyles.
Andy Rosen: And I am Andy Rosen.
Sean Pyles: We are here with the final installment of our nerdy deep dive into next-level investing. Andy, I think over the course of the series, we’ve learned that there’s a lot to investing outside of retirement funds and college savings accounts.
Andy Rosen: There’s so much. Of course, as we’ve cautioned in each episode, and we’ll do it here, a lot of these active investing options carry a lot more risk than the index funds you mentioned earlier. You can make a lot of money on them or you can lose your shirt. Whether it’s day trading or short selling or plunging into derivatives, you’ve got to know your risk tolerance and be ready to see dollars go down the drain — or, you might get rich.
Sean Pyles: It’s all really complex, isn’t it? I mean, I think our guests have done a great job of spelling out how these things work. But honestly, I just don’t want to spend my free time trying to do cost benefit analyses on what I think might happen to a given stock because, Andy, I have a garden to tend to.
Andy Rosen: I get it, Sean, but for some people, the market is their garden. Or as we’ll discover today, alternative investments are their beautiful garden, whether they’re tending to an art collection or to an investment in pork bellies.
Sean Pyles: You know what I think is a lot tastier than an investment? The tomatoes that I’m growing right now, so I’m going to stick with those. Andy, so when you say “alternative investments,” do you mean any investments outside of the stock market?
Andy Rosen: Well, some of them, yes. It gets a little convoluted, but in general there are a handful of alternative investments that are traded off of the market in different places, like commodities, like the oil and those pork bellies I mentioned. Those are often traded on exchanges. But other investments like real estate, collectibles, these are generally outside of the stock market. Depending on what you’re buying, certain alternative investments may have exposure or correlation with the stock market. But we’re going to talk about many different kinds and how they relate to markets in general.
So let’s talk about putting money into commodities, like oil and the pork bellies I mentioned before. Those are traded on commodities exchanges, not the stock exchange. Other investments — real estate, collectibles — those are generally outside of the stock market, although there is an exception in real estate investment trusts, or REITs, which sometimes are publicly traded.
Sean Pyles: And collectibles, I’m thinking about the Pokemon cards that I still have somewhere in my closet. I assume those are traded more on eBay than the stock market?
Andy Rosen: Yeah, I mean you’ve all heard about the person who found the old baseball cards in their mom’s attic and then sold them. Obviously, those are old stories now. I have some baseball cards that I found in my parents’ basement when they moved, and I have looked up what they are worth and they would not pay for the time it would take to put them into boxes, but my wife would really like for me to throw them away and I refuse.
Sean Pyles: All right, well, do you collect anything more than a hobby, Andy? Do you have a Tamagotchi stash that you’re just waiting to cash in on?
Andy Rosen: I don’t know how much Tamagotchis are worth. I did get a Tamagotchi. My neighbor gave one to my daughter. It’s really noisy and I would pay to get rid of it. If you want it, you can email me. Nothing of value, I guess, is the simplest way to say it.
Sean Pyles: OK. Are people really confident that investments outside of the traditional stock market are likely to bear fruit?
Andy Rosen: They are. And it seems like at least some of these investment vehicles are gaining wider acceptance among financial advisors. A recent survey conducted by the Journal of Financial Planning and the Financial Planning Association found that planners are more frequently recommending alternative investments than they were in 2019.
Sean Pyles: Oh, really? So what about old-fashioned garden variety investments then?
Andy Rosen: Oh, those aren’t going anywhere. Let’s put that finding in context: Things like exchange-traded funds, cash, mutual funds, stocks, bonds in general, these are still way higher on the list. The point is that alternative investments have gained a little more of a foothold in a world dominated by the stuff we talk about every week on this podcast.
Sean Pyles: Got it. All right. Well, we want to hear what you think, too, listeners. So share your ideas, concerns, solutions around next-level investing with us. We’d love to hear about your collectible collections as well. Leave us a voicemail or text the Nerd hotline at 901-730-6373. That’s 901-730-NERD, or email a voice memo to [email protected].
So Andy, who do we have to walk us through these alternative investments?
Andy Rosen: Well, Sean, today we’re joined by James Lee. He’s a certified financial planner and he’s also the current president of the Financial Planning Association, which issued the report I mentioned earlier. I did want to note that in his role as a CFP, James has what is called a fiduciary responsibility to act in the best interests of each individual client. And so he wanted me to say that depending on your financial situation, certain types of investments might fit differently into your portfolio than what we’re discussing here, or they may not fit at all.
Sean Pyles: Well, on that note, a quick reminder, we Nerds are not financial or investment advisors. We will not tell you what to do with your money. Everything covered in this episode and this series is to provide you, dear listener, with the knowledge to make informed decisions with your money.
Now, here’s Andy and James.
Andy Rosen: James Lee, welcome to Smart Money. Thank you so much for joining us.
James Lee: Andy, thank you so much for inviting me. Happy to be here.
Andy Rosen: Today, we’re going to talk about alternative investments and we’re going to be talking about basically trading in something other than the usual stocks and bonds. Really briefly, we’re going to go over things like real estate, penny stocks, crypto or even arts or collectibles.
In our last episode, we covered options, margin calls, short selling. So you can see that we’re really getting into things that might make a conservative financial planner’s hair stand on end.
But let’s just get this out of the way because I’m sure you’ve been asked about these things before: Why are alternative investments like this so different from stocks from a financial planning perspective? Is it a matter of diversification? I would guess you’re also not advising people to day trade individual stocks, or is there something more fundamental that we need to understand about the world of alts?
James Lee: So, traditional asset classes would be asset classes like stocks and bonds. Alternative investments, on the other hand, are investments that are not readily available to the public, and so that’s why they’re called alternative.
Andy Rosen: With that said, what do you tell a client who comes to you convinced that he or she wants to put money into one of these sectors? I mean, assuming you can’t or don’t want to talk them out of it, is there a way to approach these things prudently, even if it’s just approaching it with spare change as opposed to your nest egg? Can you just talk broadly about what your posture is when someone comes in and asks you about something that’s off the beaten path?
James Lee: Certainly. Well, obviously, it depends on what that investment that the client is interested in, but what I would say generally is that alternative investments are something that can be viewed as a diversifier in an investment portfolio. And certain alternative investment classes can zig when the traditional asset class zags. And that can provide some diversification benefit to a portfolio, especially in times when traditional asset classes are volatile and moving downward. For example, like we experienced last year in both traditional asset classes of stocks and bonds. However, it’s really important to make sure that the investor does their due diligence on the type of alternative investment that they’re interested in, what role that alternate investment plays in the portfolio.
Andy Rosen: Got it. Maybe you could talk a little bit about one that’s probably more conventional compared with some of the other stuff we’re going to get into. After all, a lot of people have real estate in our portfolios. I’m sitting in a house that I have a mortgage on right now.
So real estate is not an unusual thing to have as an asset. But can you talk a little bit about what it is that you’re doing when you buy real estate and maybe what it means if you’re buying something that’s a little bit more, maybe not your primary home, how people approach that?
James Lee: So taking your primary home off the table, when we talk about real estate as an investment class, it can certainly provide that diversification benefit that I was speaking about earlier. Generally, real estate is less volatile in terms of its performance over time, but also you have to remember that real estate provides, on average, lower returns than a traditional asset class like stocks. And there are ways to participate in real estate such as through real estate investment trusts, which you can invest in through publicly traded REITs.
Other types of real estate can be invested in as well, like through private real estate markets, which are not as easily available to the average investor, but nonetheless can be used as a diversification tool in a portfolio.
Andy Rosen: Let’s take a quick stop and make sure that people know what real estate investment trusts are, because I think this is a really important part of real estate investing. You do not necessarily have to buy 15 houses and commercial properties in order to have a diversified investment portfolio within real estate.
A real estate investment trust, if I’m understanding it correctly, is a company that holds a big portfolio of real estate and manages it and sells shares of itself to investors who might want to have a small exposure to that portfolio. Is that an accurate way of describing that?
James Lee: Yes, that’s exactly what it is. And while you’re holding the real estate investment trust, which is a pool of real estate investments, it also provides income over the course of the time that you hold it.
Andy Rosen: We’re going to get into a little bit deeper water here. I think commodities is something that a lot of people have heard about, especially when it comes to trading, right? We’ve all heard the stories about people trading pork bellies, corn, sugar. I’m getting kind of hungry, but not necessarily as much for oil and gold, but tell us about what happens with commodities when maybe individual investors do get exposure and where they might fit in a portfolio.
James Lee: What I would say there is that the asset classes or the types of commodities that you mentioned at the very outset, the pork bellies, that’s not something that I or many financial advisors or financial planners would be working with as a tool in their client’s investment portfolios. Those are really trading asset classes rather than long-term tools or sub-asset classes that we use in investment portfolios when we build them for our clients.
Some financial planners and advisors, however, will allocate a portion of their client’s portfolios in commodities like gold or other precious metals or energy, again, as a diversification tool in a client’s portfolio.
Andy Rosen: So at a very basic level, you’re not buying these things and storing them yourself. You’re buying contracts that give people the right to own them at some point in the future. And oftentimes, is that basically how you get that into your portfolio? I mean, you’re not keeping them in your basement, right?
James Lee: Well, some clients actually do purchase an asset class like gold, hard gold, and store them at their homes or in a safe place as part of their investment strategy. I think it’s very difficult to store oil, for example, at your home. So there are publicly traded securities that you can purchase to participate in those areas and use them as part of your overall investment strategy.
Andy Rosen: You said something that I think we might want to jump into a little bit because what you said is there is a distinction between trading and investing as a long-term strategy.
When you have someone who is interested in trading but also wants to make sure that they can retire, pay for their kids’ college, pay the electric bill next month, how do you balance those priorities if they’re interested in trying to learn how the markets work or think they have a touch but also don’t want to get themselves in trouble? What is the big picture? Whether it’s commodities or anything else, how do you approach that?
James Lee: First of all, whenever I meet with a client, we go over all of the goals that they have — short, medium and long term — and make sure that their savings and investment portfolios are structured in a way that they can meet their goals safely. As you said, I have clients, as I’m sure many other financial planners do, that have clients that would like to invest some portion of their portfolio in areas where they feel strongly about. Either they have experience in the sector that they’re employed in and feel like they have some advantage in terms of knowledge for short- or long-term outperformance or whether they are simply interested in trying to outperform markets with their own strategies.
What I generally say is that after we have insured or planned for the client to meet all of their goals with a traditional asset class allocation, we can allocate a portion of the assets that are in a safety margin to areas that a client would like to invest on his or her own.
That being said, I generally suggest to my clients that no more than 10% of an entire portfolio be dedicated to assets that are outside of the portfolio that meets all of their goals. And no more than 5% of any portfolio should be dedicated to any one security or sector.
The reason being, Andy, of course, is that if the investment goes wrong — and we’ve seen many investments that were seen as very safe investments go to zero — we don’t want a security or an over allocation to any one sector or security to blow up a financial plan.
Andy Rosen: Yeah, that makes sense. So when you said the term “safety margin,” is that what you’re referring to?
Andy Rosen: Got it. Now, this is probably going to be in the realm of trading again, but when people ask you about penny stocks or over-the-counter stocks, what do you tell them about that? I know that the consumer protections around those are not as you would expect in a public market on the New York Stock Exchange or something like that. Right?
James Lee: Well, honestly, I’ve never had a client come and ask me about a penny stock in 25 years of practice, Andy. So I don’t have familiarity with that, but I have had clients come and ask me about other asset classes or securities that are very, very risky. And I would categorize cryptocurrency in that area.
What I do say is that, again, if you have money that is simply play money that is not dedicated to reaching any of your goals and you can risk losing it all, then I’m OK with it as long as, again, it’s not part of the overall investment strategy that we agree on that is dedicated toward meeting your financial goals.
Andy Rosen: So when you talk about cryptocurrency, I’m going to guess that you heard a lot from clients about it in 2021 and 2022, but maybe not so much now.
Andy Rosen: The people who asked you about it then, have you had any follow-up conversations from people who thought they might want to get into it back then and maybe saw what has happened to the prices?
James Lee: I had a handful of clients who had invested in cryptocurrency before the real downturn in the cryptocurrency market, and we were able to use some of the losses that they had for tax-loss harvesting. So to the extent that we were talking about crypto, it was mostly about managing losses in order to mitigate taxes.
Andy Rosen: You talk about tax-loss harvesting. It’s a small consolation when you lose some money investing. It can write off investment gains elsewhere. Is that basically how that works?
James Lee: That’s right, Andy. Yep.
Andy Rosen: I did want to ask about things that might not even be seen as traditional investments. We’ve all heard the Beanie Baby story. I mean, you might equate that to crypto, but in a more conventional way, people invest in art, things they might like to have or value for aesthetic or emotional reasons, but which could potentially carry value. How do you think about that kind of thing?
James Lee: Well, I can relate, Andy, because I have the full first collection of Star Wars collectible cards out there and most of the second edition, and I enjoy them. However, personally, I don’t view them as investments or part of my overall financial strategy to meet my long-term goals. They are there to enjoy. I look at them as just Star Wars cards.
We do know and we do hear stories of trading cards that appreciate in value significantly, and that is part of markets. But again, I would not view them in my role as a financial planner as investments or as part of an overall financial planning strategy to meet long-term goals.
Andy Rosen: Well, I wish I could’ve done this as a video interview so we could have seen those cards. Those sound super cool. I love Star Wars.
Thank you for walking us through some of these alternative investment vehicles, even the ones that could potentially drive us off the road. But maybe in summation you could talk to us about the division between investment and hobby, because I think that’s what comes up a lot here as we examine the potential of investments that are more risky. You’ve indicated — and other planners have said the same thing to me — that once your actual nest egg is secure, if you want to pursue something that’s more speculative, that’s money that you might be willing to lose, but you could do it without jeopardizing your long-term financial health.
I guess my question is, where do you draw the line between financial exploration, playing around with financial instruments that might be not necessarily the most stable investments, but teach you something about the market or make you feel empowered as a part of the economic system?
James Lee: Well, I think you used two words there that are really important in that analysis or in the consideration when you’re thinking about this. You used the words “investing” and you used the word “speculation.” And there’s a big difference between investing for the long term to meet your goals and speculating to try to outperform traditional investments.
Of course, as a financial planner, my role is to help my clients invest their hard-earned capital to meet their long-term goals and objectives. But humans being human, there are some people who also like to speculate with their money. Speculative assets should be limited only to those assets that you absolutely could lose everything and it would not jeopardize your long-term goals and objectives.
Andy Rosen: James, this was a great conversation. Thank you so much for walking us through this stuff. I mean, there’s so much to consider, but it just comes back to getting your basics taken care of and then hoping that you have something extra to do what you really want to do with it. Right?
James Lee: Right. Well thank you, Andy. I really enjoyed the conversation.
Andy Rosen: Sean, talking to James and doing this extra research about alternative investments, one thing that I realized I didn’t immediately appreciate is how conventional an alternative asset can seem. So if you’re an investor with big money, for instance, there are other examples of alternative investments, such as investing in a private equity fund or a hedge fund. And what do these do? Often, they just buy and sell shares of companies on the stock market like you might do. That may not be as novel as an NFT or a bar of gold, but they’re all ways of adding new types of exposure to your portfolio.
Sean Pyles: It can help you have a well-balanced portfolio as well. A lot of advisors will recommend that people have REITs as part of their portfolio, for example.
Sean Pyles: All right. Well, Andy, thinking back to the beginning of this series, I said that I would keep an open mind to whether more active forms of investing are right for me. And you know what, Andy? I did. And I came away more adamant than ever that I’m happy to be a lazy-ish, risk-averse investor.
Andy Rosen: I never thought otherwise. In the end, I think this is a strategy that most people follow. It’s a lot of work to do the basics, to make sure you have a nice emergency fund that can protect you if something unexpected happens, to make sure that your retirement is taken care of, that you’re going to be able to pay your bills even after you stop working, and paying off short-term debt. All this stuff you guys talk about all the time on this podcast, this is a lot of work. That’s a hard assignment to start off with.
So again, alternative investments are going to be on another level of thinking about your money, and not everyone wants to do that, even someone who hosts a money podcast.
Sean Pyles: Right. Yeah, I’m happy to be focusing on the basics, investing for the long term and then, when I’m done with that, I just want to head out to my garden.
But one thing that I’m thinking about is that, from the outside, the intricacies of investing can feel like a made-up game to make rich people richer. And while I see the value in things like shorting to drive commodities to a more representative price of what they should cost, it can feel like a slippery slope from that to potentially dangerous practices like day trading, where the vast majority of people will lose money. Even though they do think they are the 1% who can get rich quick, they might just end up losing everything.
And again, power to people who want to take their time to research specific stocks and investments. Knowledge is power after all. But really, I have other things I want to spend my time doing.
Andy Rosen: Yeah, I think that’s a great point, Sean. I mean, these are different ways to invest your money. No one is saying that there are ways to make more or better money. If anyone tells you that you’re going to get money for free, you want to think an awful lot about maybe what they’re actually trying to sell you.
Sean Pyles: All right. Well, that’s a wrap on our next-level investing series. Let us know what you think about it and whether you might try your hand at some of the options we’ve explored, no pun intended, or whether you think you’ll stick with long-term index fund investing.
And if you have a money question of your own, turn to the Nerds and call or text us your questions at 901-730-6373. That’s 901-730-NERD. You can also email us at [email protected]. Visit nerdwallet.com/podcast for more info on this episode. And remember to follow, rate and review us wherever you’re getting this podcast.
Andy Rosen: This episode was produced by Tess Vigeland and me, Andy Rosen. Sean and Liz Weston helped with editing. Chris Davis helped with fact-checking. Thanks, Chris. Kaely Monaghan mixed our audio. And a big thank you to the folks on the NerdWallet copy desk for all their help.
Sean Pyles: And one last time here is our disclaimer. We are not financial or investment advisors. This nerdy info is provided for general educational and entertainment purposes and may not apply to your specific circumstances.
Andy Rosen: And with that said, until next time, turn to the Nerds.