It’s human nature to be drawn to the shiniest objects and the newest gadgets. These impulses can take hold of investors, too, when investment choices beyond the usual money market products and mutual funds beckon.
Indeed, nontraditional or alternative investments are becoming increasingly popular among individual investors. Let’s take a high-level look at some of the most popular options, and what you should consider before taking the plunge.
Gold. Gold is often seen as a safe-haven investment, or something investors turn to during times of conflict. For example, gold hit its peak price late in the summer of 2011, as the United States underwent a debt ceiling crisis, amid talk of the U.S. dollar collapsing. It’s also widely considered a hedge against inflation, as gold prices generally rise along with increases in the price of goods and services.
Pros and cons. Like traditional investments, such as stocks, bonds and cash, investing in gold has its drawbacks as well as benefits:
— Without cash flows associated with it — like bonds and dividend-paying stocks have — gold is difficult to value.
— Gold has little industrial purpose (and therefore little industrial demand).
— It can be costly to store and protect physical gold.
On the flip side, gold often moves independently of the market. Prices can be boosted by geopolitical events, such as the crisis in Crimea, and the resulting market fears. As a result, some investors use it to help offset volatility in other assets, such as equities.
Your options. Investors have a number of options for investing in gold, either directly or indirectly:
— Physical gold (buying and storing coins and bars from a dealer)
— Gold futures contracts
— Buying stock in mines and mining-related companies
— Investing in gold exchange-traded funds, such as SPDR Gold Shares
Recommendation. General commodities funds, as opposed to gold, may be better able to deal with inflation, due to their ability to diversify across a number of different commodities.
Peer-to-peer lending. Peer-to-peer lending is the “new kid” on the financial services block. It’s exactly what it sounds like: the practice of lending money to other individuals, or “peers,” without involving a traditional financial institution. It works like this: Consumers looking for personal loans, many for debt-consolidation purposes, submit loan requests and investors select which loans to fund. Borrowers make regular monthly payments, as they would to a traditional bank, and the backing investors receive a portion of those monthly payments.
Potential rates of return vary. Lending Club advertises average historical returns of 4.7 to 8.2 percent for notes with grades A through C (in other words, the highest-qualified borrowers as rated by Lending Club). Prosper’s website, on the other hand, shows a “seasoned” average return (defined as the return for notes aged 10 months or more) of 8.8 percent.
Cons:
— Peer-to-peer loans are generally not insured, making the risk of default especially distressing.
— Determining which loan requests to fund can be an arduous process.
— Investing in an individual via peer-to-peer lending represents a highly concentrated level of risk, much more than investing in an individual company (via stocks and bonds), let alone a basket of companies (via mutual funds).
Pros:
— Average returns can be higher than those from other investments, such as certificates of deposit and corporate bonds.
— Much of the work, including bookkeeping and transferring of funds, is usually handled for you by the lending platform.
— Some investors say they enjoy being able to help potential borrowers in sticky financial situations, creating a sense of community and connection in an otherwise faceless enterprise.
Your options. Creating accounts at Lending Club and Prosper — the two largest peer-to-peer lending platforms in the United States — is free, and you can usually start lending right away. Investing amounts can start as low as $25, or reach into thousands. It’s your choice.
Recommendation. A long-term investor with a properly diversified portfolio, who rebalances on a disciplined basis, likely has a better shot of reaching retirement goals than someone bitten by the peer-to-peer lending bug. However, if you do choose to dive in, make sure your peer-to-peer lending investments comprise a very small portion of your overall portfolio, i.e. 5 percent or less. Don’t lend all of your money to one loan applicant. Rather, invest smaller sums of money across a few borrowers, and see how it goes. Although you may be tempted to fund high-risk borrowers in exchange for potentially higher returns, make your lending selections carefully. Look for borrowers with solid employment histories and no public records, such as bankruptcies or collections, that would make them less likely to repay their loans.
Oil and gas. Energy prices have skyrocketed in recent years, and anyone opening a utility bill can feel the impact on their wallet. Energy sources, such as oil and gas, are used for everything from fuel and electricity to manufacturing and heat, and as worldwide demand continues to increase, investors looking for profits are lining up to get their piece of the energy pie.
Pros and cons. Like gold, the energy sector is often viewed as a hedge against inflation. Energy prices are also largely uncorrelated to stock market returns and the direction of the U.S. dollar, meaning if the stock market moves down, the price of oil and gas generally moves in the opposite direction.
However, though long-term patterns indicate an upward trend in the price of oil and gas, energy prices tend to be volatile in the short term. And although direct investments in oil and gas, such as limited partnerships, come with unique tax advantages, they also carry higher-than-average fees related to operating and maintenance costs and production expenses.
Your options. Investors have several options for investing in oil and gas, either directly or indirectly:
— Futures contracts (agreements to buy or sell in the future a quantity of oil or gas at specific prices)
— Royalty trusts (legal entities created to hold investments in natural resource companies)
— Limited partnerships (business organizations with two or more co-owners that are regularly traded on a securities market)
— Exchange-traded funds (that have exposure to either a single energy commodity or to several)
— Stocks (in oil or gas-related enterprises, such as exploration and production companies)
— Mutual funds (with exposure to the energy sector)
Recommendation. Of the above options for investing in oil and gas, mutual funds will give you the freedom of letting fund managers make the decisions on how and where to invest within the energy arena. Certain commodities funds can also give you a bit of dedicated energy position, while allowing the managers the flexibility to invest how they see fit — be it in oil, natural gas or another commodity.
It’s important to know, however, that not all oil and gas investments are created equal. Many of these ventures are scams, so if you’re considering an oil and gas investment, watch out for sales pitches that “guarantee” high returns or tout limited opportunities to invest.
Don’t jump into an investment “opportunity” without first discussing it with an independent expert, such as a financial advisor. All investments, traditional or otherwise, should be evaluated for how they fit into your overall investing and retirement savings goals, and knowing what you’re investing in is the first step!
Michael Rittershaus is the president of Smart401k, offering easy-to-use, cost-effective 401(k) advice and solutions for the everyday investor. Smart401k’s advice has been featured on various news outlets, including FOX Business, USA Today and The Wall Street Journal.
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What You Need to Know About Nontraditional Investments originally appeared on usnews.com
