How much of your wealth to invest in real estate, private equity and crypto, without overexposing your risk

Key Takeaways:
  • Alternative investments can provide meaningful diversification because they typically move independently from the stock market, helping reduce overall portfolio risk without sacrificing return potential.
  • The appropriate percentage of your wealth allocated to alternatives depends heavily on liquidity needs, risk tolerance and portfolio size. Smaller portfolios may only allocate 5% to illiquid alternatives, while larger portfolios may be comfortable committing 20% or more.
  • Opportunities such as private equity, private real estate and even cryptocurrency are increasingly accessible. With new structures like crypto ETFs and professionally managed private placement funds, investors can participate in a wider range of markets with more safeguards than before.

 

Traditional publicly traded assets, such as stocks and bonds, are the cornerstone of most investors’ portfolios, and for good reason. But opportunities for alternative investments are growing in popularity and for investors seeking greater diversification, they offer distinct advantages.

You don’t want all your money doing the same thing at the same time, and one of the strengths of alternative investments is that they have a low correlation to the stock market. Sometimes the stock market does well while alternatives are performing well, but they’re not all doing the same thing at the same time. Consequently, having a healthy portion of your portfolio in alternative investments can lower your overall risk while not diminishing your returns.

What Are Alternative Investments?

Often, but not always, alternative investments are those that are not publicly traded. An example would be buying the stock of a private company, or investing in private debt.

The most common alternative investments for middle-market investors include:

  • Private equity
  • Private credit
  • Private debt
  • Private real estate
  • Digital assets such as cryptocurrency

But how does an investor buy stock in a company if the company isn’t publicly traded? The answer is that many private companies have internal shareholders who may want to sell a portion of their stock. Investment companies and advisors have relationships with financial intermediaries that enable them to help their clients buy that stock in a “private placement.”

What Percentage of My Portfolio Should be in Alternative Investments?

For individual investors, as with all other investment decisions, the choice of whether and how much to invest in alternatives is a question of your investment goals and risk tolerance. Many alternative investments can satisfy a low risk tolerance and still provide important diversification to a portfolio.

Another key consideration is liquidity. Some alternative investments, like private equity, require you to tie up your money for several years, possibly up to a decade. If you have a portfolio of $100,000 to $300,000, we recommend that you keep no more than 5% of your portfolio in illiquid investments. However, if your portfolio is $20 million, you have a lot of cushion there and may be able to tolerate devoting 20% of your portfolio to illiquid investments like private equity.

The private investment landscape is broad and includes companies, real estate and cryptocurrencies, and many people consider commodities and precious metals like gold and silver to be alternative investments.

The way many of these opportunities work is fairly simple. An investment company will put together a portfolio of private company stocks, or real estate properties, in much the same way that a mutual fund works on the publicly traded markets. For an investment of maybe $10,000 you may own private stock in 300 commercial properties such as retail, warehousing, office buildings and, increasingly, data centers. There are solid opportunities in international real estate properties, as well, in such countries as Japan and Denmark.

There are also private equity firms that put together packages of private companies that they will improve and hold over a specified period of time, such as 10 years.

Many of these opportunities require minimum investments, anywhere from $10,000 up to $100,000 or more. The larger opportunities at private corporations may also require that investors qualify as “accredited investors,” an SEC designation that demonstrates you have $1 million in net worth or $200,000 in annual income for at least the last two years. They may also limit their placements to “qualified purchasers,” sophisticated investors with at least $5 million in liquid net worth.

There are several alternative investment opportunities are available to middle-market investors who want to diversify their portfolios and participate in a broader swath of the market. It’s important to note that only 15% of U.S. companies are publicly traded. That means there is opportunity to be mined in the other 85%.

What About Crypto?

Many investors don’t understand cryptocurrencies, so have stayed away from them. But in the past few years, crypto investing has become easier with new safeguards including government regulation and new SEC-approved exchange-traded funds (ETFs) that are indexed to the prices of Bitcoin and Ethereum. You may still be skeptical, but it’s important to note that digital currencies have been the top performing asset class in the past 15 years.

That being said, crypto is a volatile asset, and investors may rightfully be concerned about the custody of owning it. Could it be hacked? Do I have to be a blockchain user to own it? But with an ETF, you actually own a security that is indexed to crypto prices and traded like a stock. You don’t have to worry about the custody of your digital assets. That’s the fund’s job.

We recommend putting 1% to 2% of your overall portfolio into cryptocurrencies for a start.

Rebalancing

Since many alternative investments perform differently than traditional stocks and bonds, consistent rebalancing — quarterly or annually — aligns your overall risk tolerance and asset allocation so they remain within the guardrails you and your advisor have agreed upon.

 

Alternative investments can help individual investors diversify portfolios and mitigate risk, but you should discuss your goals and risk tolerance with your advisor before jumping in.

If you would like to discuss how alternative investments may strengthen your portfolio, contact an Adams Brown Wealth Consultant.