Before you make an investment, you know you should weigh the pros and cons of it as well as assess its overall risk. But how does one adequately measure risk? If you do a search on Google for “risk tolerance,” you’ll find a variety of definitions and calculators. But the reality is that the idea of “risk” factors into an individual’s emotions just as much as the nuts and bolts of their investment strategy.
In some cases, institutions will help you measure risk, but one should keep in mind that institutional lenders typically are conservative when it comes to assessing risk. So just because you are approved for a loan of a certain amount, that doesn’t mean that you can’t afford a higher amount. It simply means that the institution is weighing its own risk, not yours.
In my role as co-founder of a real estate investing and lending platform, I often have conversations with borrowers and investors about their level of risk. Everyone has vastly different circumstances, but in these conversations, I’m struck by how often people tell me they wished they would have taken a more aggressive approach when they were younger. They generally say they didn’t because they were worried about the risk.
However, when people are young, they actually should consider taking on more risks because higher growth is possible and there are a plethora of resources available to make strategic decisions. From my experience, more often than not, those who pursue a strategy of educated risks will thank themselves when they are older.
Alternative investments aren’t so alternative anymore.
Broadly speaking, an alternative investment is anything that is outside of publicly issued stocks, bonds and cash. But the term is really a misnomer these days. According to a survey by data tracker Prequin. The percent of institutions investing in three or more alternative asset classes was 50% in 2018, up from 39% in 2015. If 50% of the institutional investing population is including alt investments as part of their portfolio. Then it’s really not a nontraditional strategy.
Regardless of the semantics, many alternative investment opportunities stemmed from the 2008 recession. Traditional bank opportunities were offering next to nothing.. The markets had just collapsed creating a fear of too much exposure. And while smart investors poured into the bottomed-out real estate market. Not everyone had the capital to pursue this asset class.
Many new companies emerged from the financial crisis as a way to offer retail investors a frictionless way to invest and still produce a healthy return. With the bull market of recent years. The fact that investors are still holding assets in alternative strategies points to their potential to combat against market volatility.
Create an Risk experimentation budget.
With so much information at one’s fingertips, it’s not difficult to create a balanced portfolio that has alternative investments. After creating a healthy portfolio that’s diversified among different funds. I encourage younger investors especially to set aside an experimentation budget that allows them to pursue nontraditional options. Many self-directed IRAs also allow for alternative investments, which makes for an easy way to pursue this strategy.
Alternative investment strategies include assets like hedge funds, non-traded funds, real estate, private equity and more. Each strategy is also offered in different ways: short term versus long term. Crowdfunding options, varying fee structures, different tax implications, etc. All of these factors should be taken into consideration before making the investment.
Experimentation budgets can start small to familiarize oneself with how a new platform works. But once established and seeing percentage returns. The investor can start to pour more into each platform on a monthly basis. I recommend automatic contributions whenever possible so an investor can passively grow their portfolios.
Keep in mind that any experimentation budget should be considered risk capital and should be treated accordingly. If you are experimenting without fully understanding the asset class, invest what you can bear to lose. Remember, though, that you can generally tolerate more risk than you think you can. The adage “no risk, no return” rings true when it comes to investing.