HOW CAN YOU PROTECT your investments when the stock market goes into a steep or prolonged correction?
One way, of course, is through bonds and cash, assets that should have a place in the portfolio of every investor. The traditional allocation includes different levels of stocks, bonds and cash.
But there are other assets that deserve an investor’s serious consideration. It’s true that stocks and bonds tend to move differently throughout a market cycle. Even if both broad asset classes show gains, that increase tends to be at different rates.
For example, so far in 2019, the S&P 500 index of big U.S. stocks has risen 16.65%. Meanwhile, the Bloomberg Barclays U.S. Aggregate Bond index is up 6.35%.
If you own funds tracking both those indexes, you have a very simple form of asset allocation. It’s better than no diversification at all, and adding a greater number of stock and bond asset classes is likely to improve your long-term return.
To diversify even further, alternative investments can provide additional protection when one or more asset classes go into decline.
What Are Your Options
Alternative investments can run the gamut from those that are highly liquid to those that may be difficult to exit quickly. Alternatives include real estate, art, coins, antiques, private equity, venture capital or angel investments, managed futures, derivatives and commodities.
For investors looking for the liquidity of retirement accounts and taxable brokerage accounts, many alternative asset classes are accessible through exchange-traded funds or even mutual funds.
For example, real estate investment trusts, also referred to as REITs, offer an easy way to invest in real estate, without the headaches of actual property ownership. Owners of REITs don’t have to deal with middle-of-the-night plumbing problems at their properties, nor do they have to worry about evicting tenants who don’t pay rent. Somebody else handles all that.
A REIT ETF typically invests its assets in stocks of real estate investment trusts. These ETFs are passive vehicles, which simply track an index of publicly traded firms that hold real estate.
The iShares U.S. Real Estate ETF (ticker: IYR) is one such investment. The ETF tracks the Dow Jones U.S. Real Estate index. According to the description published by the index’s manager, S&P Dow Jones Indices, “The index is designed to track the performance of real estate investment trusts and other companies that invest directly or indirectly in real estate through development, management, or ownership, including property agencies.”
The index’s top components include American Tower Corp. (AMT), Crown Castle International (CCI), Prologis (PLD), Equinix (EQIX) and Simon Property Group (SPG). All these companies are structured as REITs, with each focusing on a different type of real estate investment.
A REIT must distribute, as dividends, 90% or more of its taxable income to shareholders. This has a couple advantages for investors seeking income.
First, distribution tends to be higher than the dividends from other types of stocks.
Second, these dividends, created through income-producing real estate, provide regular income for investors throughout good and bad market cycles.
Another Asset To Consider
Another type of liquid asset that provides diversification for a portfolio is a commodities fund. An example is the Vanguard Commodity Strategy Fund. This is an actively managed fund, as opposed to an index, although it is pegged to Bloomberg Commodity Index Total Return Index.
The Vanguard fund invests in instruments including such as commodity futures and swaps, collateralized by short-term fixed-income instruments. The fund’s commodities sector breakdown is: energy, grains, industrial metals, precious metals, softs (which includes cocoa, sugar, wheat, corn and soybeans) and livestock.
Vanguard is positioning the fund as a potential hedge against inflation. In addition, because commodities typically show a return different from stocks and bonds, they can also be a way to add diversification to a portflio of stocks and bonds.
When investing in alternative asset classes, it’s important to follow the same principles you do with your equity and fixed-income holdings. Be sure your allocation remains liquid. This is where exchange-traded funds and mutual funds have a big advantage over hard assets, including investing money in physical real estate or precious metals.
As always, be sure your overall asset allocation, including alternative investments, is aligned with your unique financial goals and your plan to achieve those goals.