A common saying in the world of finance and investing is: “The higher the risk, the higher the return.”
It is easy to understand that you would demand a higher return for an investment that does not guarantee the safety of your funds. However, you must also remember that the higher the risks, the higher the chances of losses.
Are any investment assets risk-free? Not technically. However, some investment assets are considered relatively safe because your principal investment is guaranteed or secured. Such investments include short-term government bills or bonds, some types of guaranteed investment certificates (GICs), and other fixed-income assets.
Moving farther away from relatively safer fixed-earnings or guaranteed-principal investments, you have more conventional assets, such as stocks, which are considered riskier investments.
Generally, buying shares in publicly listed companies calls for higher returns than assets, such as bonds or GICs. On the flip side, when a company’s stock price falls, this triggers a drop in the value of any portfolio that holds that company’s stock.
The possibility of losing all your investments in one single company is the reason diversification is one of the best strategies in investing.
Diversifying your investments across different assets, companies, industries, and countries is essential to minimize losses. There are investment products that make diversification more accessible. Examples of such products are exchange-traded funds (ETFs) and mutual funds.
Some investment assets suggest even higher returns than traditional stocks and bonds. These investments are usually called alternative investments.
Alternative investments are usually more complex to understand for the average non-skilled investor. Previously, alternative investments were only accessible to institutional investors or high-net-worth investors. However, the average retail investor now gets invited to invest in not-so-common assets.
What are these alternative assets? Alternative investments include private equity, private debt, real estate, commodities, precious metals, and digital currencies.
Private Equity: Most start-up or privately held companies need funds for business operations and growth. Private investors can buy into private equity funds or invest directly in these companies.
Private equity investments are not listed on the public financial markets, making them more challenging to buy or sell. Though investments in private equity may yield higher returns than traditional assets, they are riskier.
Private Debt: Some private companies take out business loans as corporate debt. When these companies offer private debt investments to investors, they generally have higher interest returns than prevailing market interest rates. As a private debt investor, you may have to bear the risk of loan defaults.
Real Estate: The most direct form of investing in real estate is buying property for rental income or resale value. Other passive ways of investing in the real estate market exist, such as real estate investment trusts (REITs), mortgage investment corporations (MICs), or real estate funds. These types of alternative investments can be complex.
Digital Currencies: The cryptocurrency wave has been shaky. While investing in digital currencies has provided exponential returns for some, it has resulted in significant losses for others. The volatility of alternative investments makes them riskier than conventional assets.
Even though you may receive promising returns, more risks are involved with investing in alternative assets. While it may be true that higher risks can yield more returns, the question is, are alternative investment assets worth the risks?
Your risk profile and investment strategy are key things to discuss with your portfolio manager. You may opt for aggressive growth or capital preservation investment strategies, depending on your net worth, age, and other factors.
You can incorporate alternative investments into your investment portfolio if you are comfortable taking on the risks. However, ensure to re-assess and balance your portfolio as your status changes over time.
Generally, investing can be risky, but so is keeping your money in cash. Inflation, higher interest rates, and the rising cost of living will erode your purchasing power if you do not earn returns on your money. Always research and invest in assets that comply with your investment risk profile and strategy.