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Alternative Investments – Part 2

February 16, 2016

I felt that my last blog on alternative investments was pretty clear, but I had some calls questioning what I wrote.  To help clarify, here is a follow-up.  I mentioned that alternatives provide correlation, diversification, downside protection, and volatility reduction. They might be right, but I don’t believe it works over a consistent and sustainable period, nor do I feel alternatives are suitable for most investors.

There are always “new” things to invest in, and there are always new methods to apply to established conventions.  Sometimes they work and sometimes not.  When providing advice, I am more concerned with minimizing the downside than grabbing the top dollar, so my advice tends to be more on the careful side.  However, that doesn’t mean that I am ignoring the new things.  I learn about them, consider them and then usually reject them.

I have learned something about investing – losses hurt more than profits help. A doubling of many nest eggs will not help an investor as much as the harm from losing half of what they have. The doubling will usually not change a person’s life or what they do. It will make them feel good, but that is usually it. On the other hand, losing half will likely cause major changes in their lives. They might have to curtail spending, go back to work or work longer, get a second job, downsize their housing situation or send a child or grandchild to a less expensive college.  The losses will hurt.

Another thing about investing is that very few nonprofessionals (and I suggest many professionals too) truly understand what they are investing in. Choosing stocks is a daunting process. Do you buy individual stocks or a mutual fund? Do you buy an actively managed fund or an index fund? Do you buy value or growth stocks; large caps or small caps; domestic or foreign stocks? What about bonds? I offer that many investors do not really understand that when they invest in a bond fund, they forever forfeit their right to receive back the money they invested. Rather, they will only receive what the market values the fund at when they are ready to cash in. Somewhat complicated and stocks and bonds are the well-known choices.

Now, let’s talk about an alternative that is easy to understand – gold.  Do you buy gold bullion, gold ETFs, gold futures, or so called gold stocks?  You can make money if gold increases in price, maybe, but you get no dividends while you are sitting with it and it can go down or have long periods of no growth.  If you buy the bullion you have to store it, insure it, watch it, and carry it if you want to sell it.  And the buyer will reduce the price by a few points since that is their profit, while you paid an extra few points since that was the profit of the dealer selling it to you.  And what would happen to its value if gold loses its allure as a substitute currency?  This is a bit confusing and it is something you understand reasonably well.  Now, apply these thoughts to hedge funds, timber, derivatives or currency trading.

There have been some good movies about alternative investing – Trading Places with Eddie Murphy, Dan Aykroyd and a stellar cast, and more recently The Big Short with Christian Bale and Steve Carell also with a great cast.  For every winner, there was a loser that believed equally as strong about the trade and sometimes the market is fixed.

The language of alternatives does not include “investing” or “gains and losses” but refers to what is done as “betting” with “winners and losers.”  Do you want to bet with your future financial security?  I don’t and I don’t think my clients or blog readers do either.

4 Comments leave one →
  1. Yaakov Sussman permalink
    February 16, 2016 2:19 pm

    Thank you for your very informative and clear articles! Being that you value more the value of minimizing losses than going for the larger gain; I was wondering your opinion on whole life insurance. While the cash value in life insurance may take time to accumulate and yield dividends – for someone in it for the long term, it generates consistent, safe and tax efficient dividends.

    Yaakov Sussman


    • Ed Mendlowitz permalink
      February 17, 2016 5:17 pm

      Previous blogs touched briefly on life insurance. It is a complicated and involved area and I do not plan on writing about it in the near future. Obviously cash value life insurance is the right product for the right people at the right time under the right circumstances.

  2. February 16, 2016 5:33 pm

    Ed you are so right about the impact of losses. I think it was Will Rogers who said “it is not the return on investment. It is the return of the investment that really matters.” The steady drumbeat of dividends from the S&P 500 stabilizes the ups and downs of the market. Give me a good dividend or fixed income portfolio any day. Having your money produce a predictable cash flow over a long period is the sure way to harness the power of compound interest.

    • Ed Mendlowitz permalink
      February 17, 2016 5:23 pm

      Thanks for comment and great quote.

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