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Can You Tolerate More Risk?
11/28/2019 6:00 am EST
Many investors can tolerate more risk than they think, especially if they invest in assets that are non-correlated to traditional investments, notes Nick Bhargava.
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 risk often has to do with an individual’s emotions just as much as the nuts and bolts of an 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 should consider taking on more risk because higher growth is possible and there are a plethora of resources available to make strategic decisions. They also have more time to recover from the inevitable drawdown. 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 alternative investments as part of their portfolio, then it’s not a nontraditional strategy.
Regardless of the semantics, alternative investment demand grew out of the 2008 credit crisis and subsequent 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 and established investment opportunities 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 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 asset classes, 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, managed futures, real estate, private equity and more, many of which aren’t listed funds. These strategies are offered in different ways: short term versus long term, crowdfunding options, varying fee structures, different tax implications, etc. All these factors should be taken into consideration before making the investment.
Experimentation budgets should start out small to familiarize you with how a new investment and the platform it utilizes works, but once established, the investor can invest 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—especially if the investment is non-correlated with your core holdings. The adage “no risk, no return” rings true when it comes to investing.
The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.
Nick Bhargava is Co-Founder and EVP of GROUNDFLOOR, a real estate investing and lending platform that is open to non-accredited investors.
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