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Alternative Investments for Savvy Retirees – Part 2

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In the first part of this series, I noted that the baby boom generation has lived through a uniquely stable period in human history. Sadly, there is no guarantee that this will last.

There are forces in the world that could lead to unprecedented disruptions in modern life. I hope not. There are also forces for stability. But part of me prepares for the worst, all the same.

So, in the last post, we explored how you can diversify some of your wealth out of U.S. dollars and/or out of paper assets. We discussed three of the more conservative alternative investments: international stocks, real estate, and small business.

The vast majority of investors should not stray from those three proven and relatively predictable alternatives. New investors, especially, or older ones that need to keep their finances ultra-simple, should not be looking for alternative investments at all. By definition, alternative investments are riskier and more complex than the mainstream options.

But, for those few with the temperament and means to invest further afield, we’ll now investigate some of the more exotic and riskier choices….

Gold

The classic alternative investment, the one with the longest history of preserving wealth, is gold. Many consider gold the ideal form of “money.” It is scarce, durable, portable, divisible, interchangeable, and recognizable. That’s why gold has served well as money since the dawn of human history.

Some modern experts consider gold to be old-fashioned, and a poor investment because it doesn’t produce income. But gold still possesses those valuable characteristics of money, and can still hold its value, albeit with some volatility. The most important property of gold, in my experience, is that it tends to zig when the stock market zags. If you needed to raise cash during a severe market downturn, especially one precipitated by a natural or man made disaster, you would likely be very appreciative of your gold holdings.

That said, gold is not for everyone. As mentioned, its price can be volatile. If you need to sell it at the wrong time, you could take a beating. That’s why this alternative is best for experienced investors with plenty of cash reserves on hand.

Also, though I took considerable profits from gold in the first decade of this century, it isn’t typically a growth investment. At best, it may hold its value against inflation over time. And recent research questions even how well the price of gold correlates with inflation or the dollar.

If you are attracted to investing in gold, first read everything you can about it. Start with my earlier post, Should I buy gold?, written in 2011. For most new investors, the safest way to own gold is through an ETF such as GLD, which has been a component of my portfolio now for many years.

Lastly, remember that gold is a risky, volatile, speculative investment. I don’t own it in any retirement accounts, and would not make it a core retirement holding. Owning gold is a luxury, a potentially expensive insurance policy, for consideration by affluent and experienced investors only.

Bitcoin

Compared to gold’s substantial history, Bitcoin — a decentralized “digital” currency introduced in 2008 — is a rank upstart. Bitcoin is independent of any government or central bank. Bitcoins are created as payment in an ongoing competition in which “miners” apply their computing power to process transactions for the system into a secure, public ledger. The “coins” are then traded on an open market for whatever people will bid. What do you actually get when you purchase Bitcoin? You get a private numeric key that proves your stake in an inviolable public transaction….

Bitcoin is based on advanced mathematics and cryptography that have so far withstood attack. It may eventually prove a useful alternative investment for diversifying wealth in the modern era. Bitcoin has most of the advantages of foreign-based assets, but its value is not subject to any government’s whims. Big companies like PayPal, Microsoft, and USAA are now supporting it in different ways. And there are geopolitical pressures — like currency issues in China and India, for example — that are creating demand for Bitcoin.

Bitcoin has those same six essential money properties as gold. And it could be more secure and stable than dollars in certain scenarios. According to some experts, it has already shown low correlation and higher risk-adjusted return than the stock market.

Buying Bitcoin is also an investment into a cutting-edge technology. In addition to offering a politically independent currency, Bitcoin, or its underlying “blockchain” technology, could form the basis for widespread tamper-proof contract and payment systems under-girding the Internet, making small and large transactions easier and more secure. That’s the upside.

But if gold is esoteric, volatile, and risky, Bitcoin is a hundred times more so. Inexperienced investors will be burned. Probably by the score. Heed my experience:

I recently put a small portion of our liquid assets in Bitcoin, as another form of “cash,” but with a speculative element. In the weeks following my purchase, Bitcoin rose about 20%. Oh, what a savvy investor I am! Then China made some noises about increased Bitcoin regulation, and prices dropped 30%! I was in the hole. OMG, panic and sell?

But I’ve been down this road many times before, and did not react emotionally. I’ll hold my Bitcoin a long time and perhaps I’ll make money, or perhaps I’ll lose it. In the meantime I’ll have a liquid asset not strongly correlated to my other holdings. The real reward for me is financial education. But, the rest of you should be extremely wary!

Understand that, like most currencies, Bitcoin is only worth what people are willing to trade for it. Bitcoin is an even more abstract investment than gold. It might be a fad, and it could be easily superseded by other, better technologies. (It already has a number of competitors in digital currencies, for example Ethereum.) Prudent investing experts like Mike Piper at Oblivious Investor routinely pan trading in foreign currencies. And many other experts have forecast that bitcoins will eventually have no value. Lastly, the transaction costs for trading in Bitcoin are not trivial, starting at about 1.49% on Coinbase, the leading U.S.-based broker.

If you can’t handle the kind of extreme volatility I’ve experienced in just the last month without panic selling, stay away from Bitcoin. A sophisticated investor might diversify into Bitcoin with a small amount of money that they can afford to lose. But Bitcoin would be totally inappropriate for core retirement savings, or for a young person just learning about investing.

Peer-to-Peer Lending

Lastly we’ll look at another Internet-enabled asset. Peer-to-peer (P2P) lending is a form of borrowing facilitated by the web, that cuts out the expensive middlemen, making it cheaper for borrowers to borrow and more profitable for lenders to lend. If you have some capital to put to work, you can do so in a peer-to-peer network, and get higher returns than are possible with conventional investments.

Peer-to-peer lending is the one alternative investment mentioned here that I have no personal experience with. So, reader beware! But it’s a popular topic elsewhere in the blogging world, has worked for many people, and seems a reasonable approach to diversifying a small portion of your assets.

But, as always, there is a risk. The newer P2P networks may not gain traction and may not generate enough transactions for profitability. Almost all the P2P networks are going to see higher default rates, because the borrowers tend to be less traditional. So, in order to hedge against those higher default rates, you must diversify your loan portfolio. That means you need to do more research, and make more loans. And that costs you in the time required to manage your P2P investment.

If P2P lending appeals to you, there are a number of platforms to choose from. Early entries, like Lending Club or Prosper, are primarily for consumer loans. These feature some of the highest rates of return. But understand you may be financing people with poor credit buying larger flat-screen TV’s. Personally, that’s not how I want to put my money to work. (For a different option, that involves doing good with your capital, but foregoing an investment return, check out Kiva.)

A newcomer in the P2P field is dedicated to financing real estate transactions. In theory, with real property as collateral, your peer-to-peer loans should be safer. And rental income from the properties, in some cases, could ensure regular loan payments. Though, understand some of these loans are also probably for house flippers. If you’re comfortable with real estate, but don’t want the hassle of owning and managing your own properties, and like the idea of peer-to-peer lending in that domain, check out PeerStreet.

Taking Stock

Alternative investments, even for savvy retirees, are by definition, not mainstream, not guaranteed, and not entirely safe. If you want to make alternative investments, first do your homework and get experience slowly. Know the investing landscape. For the riskier alternatives, don’t invest sums that you can’t afford to lose.

Though the more conventional alternative investments — international stocks, real estate, and small business — have at times represented a substantial portion of my net worth, the riskier alternatives discussed above have never constituted more than a few percent of it.

Patience is essential with the more volatile alternative investments. They may be in favor for only short periods of time. If you “need” them to perform a certain way, or panic out at the wrong time, you’ll lose your shirt.

Alternative investing is not about piling into some asset class that is “sure” to go up if the rest of the financial world crashes. Each of these investments has its own vulnerabilities and could be very risky under certain conditions. Hoarding a single asset class will only increase your vulnerability. Don’t fixate on a single version of the future.

Above all, stay diversified. Keep your significant holdings in mainstream stocks, bonds, and cash. Alternative investments are, fundamentally, just an advanced form of diversification. And diversification remains your single most powerful tool against risk.

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Coming up: In my next article — my annual portfolio review — I’ll post my current portfolio allocations, and report on how they performed in 2016!

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