April 6, 2020
With all the volatility in the stock market right now caused by the coronavirus outbreak, more investors are looking into alternative investments as a means of protecting themselves against this volatility by diversifying their investment portfolio. But alternative investments, like any investment, have some risks associated with them. In this article, we will describe the principal types of alternative investment risk and what you can do as an investor to mitigate them.
While a lot of investors have become interested in alternative investments because of the volatility in the stock market, there are alternative investments are even more volatile than the stock market, which has an annualized volatility rate of 19.7%.
Bitcoin has become a trendy alternative investment in recent years, due to steep increases in prices. But there have also been steep falls as well, and this has led the currency to have a volatility rate of 130%. Other leading cryptocurrencies have even higher volatilities.
Even venerable types of alternative investing can have excessively high volatility rates. Venture capital, for example, has had volatility rates as high as 100% in recent years, and gold’s volatility rate of 15.8% is not much better than the stock market.
But there is one type of alternative investment that offers volatility rates that are significantly lower than the stock market: multifamily real estate, which has a volatility rate of only 7.75%. This means that the swings in prices of stocks are nearly triple the swings in the prices of multifamily real estate.
One of the chief drawbacks of alternative investments in comparison to stocks and most other traditional investments is liquidity. While an investor can generally convert stocks (and other traditional investments) into cash easily, many alternative investments are, to varying degrees, illiquid.
Many hedge funds, for example, have long lockout periods and limited withdrawal times after this period ends. With other alternative investments, such as venture capital, it may not be possible to convert your investment into cash for many years or until a certain pre-defined event, such as the sale of the company or its initial public offering.
Multifamily real estate investments are illiquid, too. This is because it is usually not so easy to sell a multifamily dwelling. While you cannot fully mitigate this risk, you can at least plan around it through a real estate investment trust (REIT), such as what DiversyFund offers, as your investment is locked in for just the investment term which is approximately 5 years instead of some indefinite period.
One of the risks that both stocks and alternative investments share is principal risk. This means the possibility that you can lose all or a significant part of the money that you initially invested. This is usually not a major concern when making a long-term investment in a stock from a well-established company, but even some of these companies have collapsed in recent decades as well as a larger number of startups.
Typically, the risk that you may lose investment principal is even greater when it comes to alternative investments. For example, a number of cryptocurrencies have been completely wiped out, and investors have also lost hundreds of millions of dollars through fraud as well. Venture capital and private equity also carries a considerable risk of principal loss.
But while the risk of principal loss exists even with multifamily real estate, this risk is far less, as such assets have long-standing tangible value and provide something that people will always need: homes. Furthermore, holding multifamily dwellings long-term can mitigate the little risk that there is.
Most people who invest in stocks do not worry about transparency risks, in spite of a number of prominent scandals in the last few decades. This is because the SEC regulates publicly-traded companies, who themselves must undergo regular independent audits.
As for alternative investments such as venture capital, private equity and hedge funds, while the government does regulate them, there is less transparency than for stocks, which is one of the reasons why the SEC requires investors of these types of assets to be accredited.
Transparency risk is much more of an issue for some other forms of alternative investments, such as cryptocurrencies, where there is little or no regulation. Also, while the transactions conducted in these currencies are inherently transparent, what underlies a particular currency and gives it value is not readily apparent to an investor.
But there is considerable transparency when it comes to multifamily real estate. This is because mortgages are among the most heavily regulated securities, and every aspect of them and their underlying assets is transparent to all parties.
With the SEC-qualified Growth REIT that DiversyFund offers, investors get an extra layer of protection, as the government regulates it as a security in addition to regulating its underlying assets.
While fees on traditional investments have been trending lower in recent years, the same cannot be said of many alternative investments.
Hedge funds can incur annual management fees of up to four percent as well as performance fees that can be as high as 50%. You can even find yourself paying many layers of management fees. Venture capital firms also charge high management fees and typically keep 20% of profits.
With traditional multifamily real estate, someone has to manage the property, and this is not inexpensive. Even if you manage the property yourself, there are all sorts of recurring expenses that will eat into your bottom line.
But not all multifamily investments require fees. DiversyFund is revolutionizing this by eliminating platform fees when you invest in their fund, the DiversyFund Growth REIT.