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.
While you can gain exposure to real estate through real estate investment trusts (REITs), you can also invest by directly owning property. Direct ownership comes with its own set of potential rewards and trade-offs.
When an investor directly owns real estate, they keep the full benefit of rental income and any gain on sale, rather than sharing returns through a pooled investment. In addition, certain costs of owning the property (e.g., maintenance and renovation expenses) 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 generally held its value during periods of stock market volatility. Over long periods, economic data also suggests that non-commercial residential real estate tends to grow faster than the rate of inflation.
Direct ownership also brings some unique risks. One of the biggest is liquidity risk: selling a property often requires real estate agents, title companies, and inspection specialists, which can add both time and cost. Closing a sale is rarely quick and often takes several weeks or months. Negotiating contract terms 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 expensive. If you want real estate exposure without these potential 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. Precious metals often show a negative correlation with market returns: when the market declines, precious metal prices tend to rise. They also often show a positive correlation with inflation: 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 through schemes involving these investments.
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