Sir John Templeton, respected investor, banker, and fund manager was on the right track when he said, “Diversify.  In stocks and bonds, as in much else, there is safety in numbers.”  From companies diversifying a product line to investors diversifying a portfolio, there is not only safety, but a much greater likelihood of growth when you have your money, assets, products — whatever — strategically allocated among different pieces of the pie. 

Your portfolio might seem diverse, but your investments might be more alike than not.

Diversification is probably the most important aspect of a healthy investment portfolio, regardless of the type of investment.  If one segment of your portfolio lags or even fails, diversification will protect it from a clean sweep during a bad economic downturn.  But this simple concept has tripped up even the smartest investors, costing them many thousands of dollars that would otherwise be MAKING them even thousands more.

Here’s the problem.  Too many people believe they are diversified through traditional investments in the stock market because they own multiple stocks, mutual funds, bonds, and the like.  But that is simply diversification within the stock market, not within other assets or industries.  The only way to truly be diversified is by owning assets that are not correlated to each other within the economy.  (The correlation of investments refers to the direction of price movement.  If investments are non-correlated, it means that the price movement of one will not affect the price movement of the other.)

Being invested in various sectors of the stock market is a good start.  But a truly diversified portfolio would mean expanding your investment dollars to include non-traditional markets such as real estate, gold, venture capital, oil and gas, or maybe different lending opportunities.  Why?  Because most of these investment types are not correlated to the stock market or to each other.  Plus, the very nature of a non-traditional investment will give a portfolio a more favorable risk-return profile.  Now, if the economy took a bad downturn, some of these industries might be similarly affected (their price or value would move in the same general direction), but they’re diverse enough that they wouldn’t all be affected at once, and certainly not to the same degree.

Do you have any non-traditional investments in your portfolio, and are you invested in enough of them to be sufficiently diversified?  If you don’t have your investing dollars allocated across multiple non-correlated assets, you’re putting your potential earnings, and even your principal, at risk!

As with anything, though, there’s always an upside and a downside.  As fully-committed as I am to non-traditional investments, there are a few things you should know before you choose your next venture.  Let’s look at some of the pros and cons associated with non-traditional investments.

The “Cons”

One of the cons of non-traditional investments is that, compared with traditional investments, they are much more illiquid.  Buying or selling in the stock market is instantaneous, which makes it very liquid.  Our fund, Guardian, for example, can’t just trade electronically and find a buyer for whomever is selling.  You might have heard me say that we don’t have a lock-up period on our investments, and it is true.  Still, Guardian is considered an illiquid fund because we try to have all of our capital deployed into investments at all times.  (Otherwise, it dilutes our investors’ returns!)  Another thing to be aware of (though this is not the case for Guardian) is that some types of non-traditional investments could need to make capital calls due to its illiquid nature.

Another con with some non-traditional investments is that the wrong ones can come with great risk.  This would be very true when investing in venture capital-type deals.  Many could go to zero in value while others could become homeruns.  Venture capitalism is definitely a high risk, (possibly) high reward investment.

And what about the fees associated with non-traditional investing?  This could be considered another con, since, many times, non-traditionals have larger fees than traditional investments do.  In my experience, the fees are usually a reflection of what it takes to find, initiate, and manage the investments.  Since they are not as easy to come by or as easy to manage as traditional investments, non-traditionals usually involve a lot more work for the manager or sponsor and require a larger support team for its successful execution.  I never worry as much about the fees as I do the net return, though.  Done properly, what it takes to get there is not nearly as important as the final result.

The “Pros”

Now, let’s get to the pros.  Although illiquidity can be perceived as a negative, it can actually work to an investor’s favor.  For instance, what happens when the economy begins to melt down?  Our impulse is to sell!  Well, it is easy to sell those liquid assets.  However, that may be the wrong thing to do at the time.  Not being able to make the irrational, impulsive decision to sell at a down moment can work to an investor’s benefit.

Another pro is that non-traditional investments can compete better in their space.  What do I mean by that?  When investing in the stock market, it is almost impossible to get a leg up, especially as an average investor who doesn’t do it for a living.  If the market goes up, so do your stocks, and if it goes down, you are stuck in the same sinking boat, unless you jump ship.  With non-traditional investments, many times, the manager or sponsor has a competitive advantage or a whole lot less competition to even worry about.  For example, Guardian is in a niche market purchasing homes in the $25K to $50K range.  Most investors or institutions are not set up to invest in that type of niche space.  This gives us a huge advantage!  By building the systems, processes, and economies of scale, we can reap the rewards of investing in a relatively untapped niche market.

Since we started in this business over 10 years ago, we’ve noticed an increase in non-traditional investments.  They are becoming more widely accepted since investing data shows that they help bolster a portfolio’s bottom line while reducing risk.  Large endowments like Harvard, Stanford, and Yale have moved the majority of their multi-billion-dollar portfolios into non-traditional assets for many of the same reasons that we tout are good for our investors.  It’s reassuring to know that we have something in common with the big shot Ivy League endowments, run by some of the smartest people in the world.