It is not uncommon for a friend, family member, neighbor or old classmate to reach out with a “can’t miss, you gotta get in on the ground floor” opportunity. These opportunities can range from being a part of a new business venture, a real estate opportunity or a type of loan to name just a few. There is nothing inherently wrong of course with listening to a proposed opportunity (even from a former classmate your barely knew that is suddenly calling you “buddy”). What is important is to separate the relationship you have with the person and the merits of the presented “alternative” investment. Items to think about:
What is an alternative investment? It is actually easier to define what an alternative investment is not. Traditional investments would include stocks, bonds, cash and possibly some forms of liquid real estate (mutual funds and exchange traded funds would be included since they would hold these types of investments). Everything else could be considered an alternative investment, things like private equity, hedge funds, wine, gold, private real estate, art work, coins, business ventures, you name it! The list is vast, and we could continue on for some time, but I am sure you get the idea.
Why would someone want to think of investing in something other than traditional investments? The main reason is to have different investments in a portfolio that do not have to depend on each other to be able to make money. Alternative investments may perform well even if the S&P 500 is struggling (they may also perform poorly when the S&P 500 is doing well). Having different types of investments can diversify your portfolio and lessen the pain during down times. A term often used to measure this is called “correlation”. Correlation can range anywhere from 1 to -1, if investments are perfectly correlated (go up by 10% or down by 10% at the same time every time) they would have a correlation of 1. If investments are negatively correlated (one is up 10% and the other is down 10% for instance or vice versa every time) they would have a correlation of -1. If investments are completely non-correlated (one is up 10% and another is up 5% in one scenario, same investments but one is down 5% and the other up 4% in another scenario) they would have a correlation of 0 (this is optimal but hard to find).
How should I research? Conducting proper “due diligence” on a proposed investment opportunity is critically important. For starters you would want to consider the following: What is my potential rate of return? How long will my funds be tied-up? What are options to get my money back? How do I find out the ongoing value of my investment? These questions are only a beginning point because each type of investment has risks specifically associated to its style (real estate would have potential geography risks for instance). That being said, the most important item to research is the manager (manager selection). Questions like the following should be asked: How many of this type of investment has this group done in the past? What is the background of the key players? What kind of returns have they been able to achieve with past investments? How have they performed during good economic times? How about bad economic times? Where are funds held? Can funds be verified? Who is their auditor? Who manages the books for the group? Are the books open for inspection? Be cautious of any Red Flags, many for Bernie Madoff were ignored. Again, this list is not exhaustive but I am sure you get the idea. Credibility and character are paramount. If you start to get a bad feeling with some of the responses you receive (not just the answer but how they answer), this may not be the right opportunity for you. DO NOT RUSH or GET HURRIED IN THE PROCESS.
There are good alternative investments out there (many bad ones of course as well, be cautious). Also, as noted above these investments are often illiquid (limited to no access to funds). It is important to determine what percentage of your assets you would have locked-up for an extended period of time.
The next time you are at a family reunion and Cousin Billy mentions that “can’t miss, you gotta get in on the ground floor” opportunity, let him know you have some key questions you would like to discuss at some point in the future (pay attention to his reaction, could be a “tell”). Always remember the following Will Rogers quote when dealing with money: “I’m not so much interested in the return ON my money as I am in the return OF my money.”
Troy Kuhn, CAIA℠, MBA, CFP®
This commentary is provided for general information purposes only and should not be construed as investment, tax or legal advice. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable but is not guaranteed.