Now that share prices have regained the ground they lost back in March, some analysts are worried the recovery has gone too far -- that a bubble might be brewing. Those bubble fears might have you wondering if it's a good time to start investing outside the stock market, say in assets like gold and real estate.
Gold and real estate both fall into a category of investments known as "alternative assets." The term describes any investment that's not a stock or bond. Gold and real estate are the best-known options, but other choices include silver and other precious metals, bitcoin, mineral rights, timberland, livestock, and even collectors' items like classic cars and artwork.
The pros of alternative assets
Alternative assets are appealing in uncertain times because they don't move in lockstep with the financial markets. Some asset types, like residential real estate, simply aren't affected much by what's happening in the stock market. Other assets, like gold, tend to move in the opposite direction of the stock market. If investors get spooked into a big equity sell-off, for example, the value of your Apple shares probably get pulled down too -- even if the company fundamentals haven't changed. But property values will hold their own, and you'll likely see the price of gold rise.
Given that behavior, if you are certain a market crash is just around the corner, then now would be the time to move some of your wealth into gold or other alternatives.
The cons of alternative assets
On the other hand, if the crash you're predicting doesn't materialize, you may regret your decision to buy into alternative assets. That's the core problem with making decisions based on what you think might happen -- if your outlook doesn't pan out, you stand to lose big. The worst-case scenario is you'd miss a run-up in share prices and see your alternative assets stagnate or drop in value at the same time. Then, if you want to reduce your exposure to the alternatives, you may have to sell low to liquidate and buy high to get back into equities.
Another drawback is that alternative assets generally aren't as liquid as equities. If you change your mind about owning real estate, for example, there's a long process involved in selling it. The same goes for cars, artwork, and livestock. You can own some of these assets indirectly through exchange-traded funds (ETFs) and real estate investment trusts (REITs), which are more liquid than owning actual commodities or property. But even those funds may have less demand than, say, the S&P 500 index fund.
Alternative assets can also be wildly volatile. Bitcoin is the poster child of volatility; the cryptocurrency gained 1,400% in 2017, but regularly experiences corrections in excess of 30%. The price of gold, too, can move quickly in both directions. Between 2012 and the end of 2015, for example, the price of gold fell 40%. And this year, gold rose some 17% between June and August, only to fall about 6% since. Even residential real estate, one of the least volatile investment types, has had periods of volatility -- as we saw in the 2000s.
How to add alternative assets to your portfolio
Alternative assets can diversify your portfolio and offset some of the volatility you'll see in equities. But don't forget: If an asset tends to go up when equities are down, that same asset will go down when equities are up. Accept that fact and you are ready to add some alternatives to your portfolio -- not because you think the market will crash tomorrow, but because you want to diversify for the long term.
A good starting point is an ETF that holds assets you understand, like real estate or gold. The advantage of alternative asset funds is that they're more liquid and easier to own than the actual asset. There is a disadvantage, though. Funds are more closely correlated to the stock market than, say, an actual piece of property. Given that you can buy a share in a real estate ETF for about $100, but you can spend 100 times that on a single property, the trade-off may be worth it.
Vanguard Real Estate ETF (NYSEMKT:VNQ) is a popular choice for real estate exposure. The fund invests in roughly 180 REITs that own residential properties and commercial properties across a variety of industries. VNQ has an expense ratio of 0.12% and net assets of $57.4 billion. If you're interested in owning gold, SPDR Gold Shares (NYSEMKT:GLD) is a gold ETF backed by actual gold reserves. The fund has an expense ratio of 0.4% and $78 billion in assets under management.
Plan on limiting your alternative holdings initially to 5% of your portfolio. You might even start out with 1% or 2% until you're sure you're comfortable with how these assets behave.