Investments in assets like real estate and precious metals offer additional ways to diversify a portfolio. We’ll discuss the specifics of both in this chapter.
While we’ve already discussed gaining exposure to real estate through real estate investment trusts (REITs), direct investments in real estate can involve other investment benefits and risks.
When an investor directly owns a piece of real estate, they solely gain benefits related to renting out or selling the property instead of sharing those gains in a pooled investment. Additionally, certain expenses related to owning the real estate (e.g. maintenance, renovation costs) may be tax deductible if the property is being rented out or is considered 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 tends to hold its value when volatility exists in the stock market. Additionally, economic data suggests that non-commercial real estate properties tend to grow faster than the rate of inflation over long periods of time.
There are also some unique risks. As most owning real estate can attest, liquidity risk is a big concern. Selling a property typically involves real estate agents, title companies, and inspection specialists, resulting in sometimes significant time and money commitments. Closing on a property sale is rarely quick, and will likely take several weeks or months. Contract negotiations between the buyer and seller can also complicate the transaction. Bottom line - buying or selling actual real estate can be a huge hassle. For those seeking real estate returns without these potential burdens, REITs are a suitable alternative.
Investors can diversify their portfolios with direct exposure to precious metals, which include:
Direct investments made into 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. Additionally, there tends to be a positive correlation between inflation rates and precious metal valuation. When inflation rises, so do precious metal prices.
There are risks to be aware of with these investment vehicles. Many times, investments in precious metals involve large fees, including insurance, shipping, or maintenance fees (if a third party holds the precious metal). There are also numerous instances of investors being duped and defrauded in schemes involving these investments.
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