Investments in assets like real estate and precious metals can add another layer of diversification to a portfolio. This chapter looks at how each one works, along with the main benefits and risks.
We’ve already covered gaining real estate exposure through real estate investment trusts (REITs). With direct real estate investing, you own the property itself, which changes both the potential rewards and the risks.
When you directly own real estate, you keep the full economic benefit from renting the property or selling it later, rather than sharing returns through a pooled investment. In addition, certain ownership expenses (for example, maintenance and renovation costs) may be tax deductible if the property is rented out or treated as an investment property.
Real estate also tends to act as a hedge against both market and inflation risk. With the exception of the Great Recession, the real estate market has tended to hold its value during periods of stock market volatility. Over long periods, economic data also suggests that non-commercial real estate properties tend to grow faster than the rate of inflation.
Direct ownership comes with some unique risks. As many property owners know, liquidity risk is a major concern. Selling a property typically involves real estate agents, title companies, and inspection specialists, which can require significant time and money. Closing a sale is rarely quick and often takes weeks or months. Contract negotiations between the buyer and seller can also delay or complicate the transaction. In other words, buying or selling real estate can be time-consuming and operationally complex. If you want real estate exposure without these burdens, REITs can be a suitable alternative.
Investors can diversify their portfolios with direct exposure to precious metals, which include:
Direct investments in these commodities tend to act as hedges against both market and inflation risk. There tends to be a negative correlation between market returns and precious metal valuation: when the market declines, precious metal prices tend to rise. There also tends to be a positive correlation between inflation rates and precious metal valuation: when inflation rises, precious metal prices tend to rise as well.
These investments also come with risks. Precious metals can involve large fees, including insurance, shipping, or maintenance fees (if a third party holds the metal). There are also numerous instances of investors being duped and defrauded in schemes involving these investments.
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