Invest Outside the Box

Most people consider the Morningstar Style Box, the ubiquitous 9 square grid seen all over financial publications, as the entire spectrum of investible assets. These same individuals consider stocks, bonds, and real estate to be the only acceptable forms of investments (aka: asset classes). While these certainly are the primary investment vehicles used by most, and granularity within these sectors allows further diversification, they do not represent the whole spectrum of investment options. Building a well diversified portfolio entails combining assets that compliment each other and reduce risk; in finance parlance, they have low correlations. During times of stress, correlations tend to be high, which means assets move in tandem; this explains why even the most diversified stock and bond portfolios sometimes lose value in a down market, albeit not as much as the overall market. However, there are many asset classes that are often overlooked, despite their low correlations.

• Become a venture capitalist
  Venture capitalists provide early stage financing, either through debt or equity, to companies they believe will be profitable. Unfortunately, not all good companies have access to venture capital because of their size, and not all companies are good investments. Given the current economic climate, even good small businesses are having a very difficult time obtaining bank financing. Do you know someone who recently started a company or is thinking of expanding their existing profitable business, but is unable to obtain financing? If you believe in this person and their product/service, then consider investing in their company by lending money at a reasonable market rate, buying shares in their firm, or both. Your investment in their firm will be less tied to the stock market, give you diversification, and of course help a small business; all good things.

• Invest in consumption
  Another way investors can enhance their portfolio returns and minimize risk is by investing in commodities. Many people think of commodities as just gold or silver. However, commodities are a much broader category than just these two metals. Commodities are divided into two categories: Hard and soft. Hard commodities are those that are mined such as gold and silver, while soft commodities are grown and consumed. Commodities are not only a good hedge against anticipated inflation, but they also have a low correlation with the stock market. A more recent trend in commodities investing is in water rights. Water is a scarce resource and some experts predict that in the future, territorial conflicts will shift from energy to water rights. If this prediction-theory is correct, investing in water rights may be lucrative.

• Collect something
  Collectibles such as stamps, art, wine, coins, vintage car collections, etc. are usually considered hobbies, but they are all forms of diversifiable investments. The mere existence of large auction houses validates the significance of the collectibles market. Many famous entrepreneurs and entertainers from Bill Gates to Elton John have invested in art and collectibles. In 2006, famed entertainment mogul David Geffen, purportedly auctioned off a painting by American painter Jackson Pollock for $140 million, the highest single amount paid for a work of art. Beyond collectibles, some people buy and sell websites. According to a recent Bloomberg Businessweek article, an investor bought business.com in 1995 for $150,000, and sold it four years later for $7.5 million. The most important rule of investing in collectibles is to buy what you know and love. Don’t buy baseball cards just because you think they will go up in value someday, buy cards because you understand and love the game.

The aforementioned investments are not risk free, and require a tremendous amount of due-diligence prior to making a commitment, which is why their payoffs are so great. Therefore, it is important to know what you are investing in before committing your hard-earned funds. Investors should also keep in mind that such investments are often illiquid, do not generate cash, require a long time horizon, and may have unique tax consequences. Whether you decide to lend capital to your best friend from high school for her new ultra-hip restaurant, or buy stock in your college roommate’s medical device company, it is always a good idea to draft the appropriate legal documents to protect both parties. Lastly, as with any asset class, determine an appropriate and strategic percentage of your portfolio to allocate to such investments which are based on your goals and risk tolerance. Remember to always remain within that range; do not overexpose yourself to any investment. And as always, an informed investor is a successful investor.