It’s good practice to diversify your retirement portfolio to build wealth that will last for decades after you leave the workforce. Diversification includes traditional investments like stocks and bonds, but these are only a starting point. Read on to find out why diversification is important, what alternative investments can do for your portfolio, and why farmland may be just the asset class you need.
Diversification is key
Diversification, or investing in multiple uncorrelated securities or asset classes, is important for a couple of reasons.
First, a diverse portfolio is more resilient to shocks. For example, look at the impact of COVID-19 on the stock market this year. Stocks went into a tailspin in March, and although they have since recovered, this was a painful and scary moment for investors. A diverse portfolio offers protection against these kinds of losses.
Related, diversification can reduce volatility. Volatility is the bane of long-term investors, both because it causes panic, which can lead to panic-selling and other bad investment decisions, and because it reduces your returns in the long run (“volatility drag”).
This leads us to the third reason diversification is essential: A diverse portfolio can provide better returns. Perhaps counterintuitively, even though the stock market has higher average annual returns than the bond market, a portfolio of half stocks and half 10-year Treasuries performs better in the long run than a portfolio of 100% stock. This is because stocks outperform in good years but fare much worse in bad years.
Diversification: beyond traditional investments
It is important to both diversify within asset classes and across asset classes. For example, instead of owning stock in a single company, you achieve better diversification through buying stock in multiple companies across industries, or through purchasing an ETF that tracks the top performing companies in the market.
Beyond diversifying within your stock portfolio, it’s important to diversify across multiple asset classes. Traditionally, investors split their investments among stocks, bonds, and cash and cash equivalents. Bonds (especially high-quality government bonds) are seen as a good counterbalance to stocks, as they are negatively correlated with the stock market and are less volatile. Conventional investment wisdom recommends a 60/40 split of stocks to bonds in a retirement account, although this is now being called into question, and for many investors, this is likely too conservative and will not generate the returns needed to support a comfortable retirement.
The good news is that for savvy investors, there is a wide range of investment opportunities available beyond this limited universe.
Alternative investments broken down
An alternative investment (or “alternative”) is an investment in anything other than mutual funds, publicly traded stocks, bonds, or cash. This is a broad universe encompassing everything from private equity and venture capital to commodities, real estate, farmland, or fine art.
Relative to traditional investments, alternatives have several benefits. Generally speaking, alternative investments are uncorrelated with public markets. This means that their value is not tied to the Dow Jones Industrial, S+P, or other stock or bond index. Thus, adding alternatives to your portfolio increases diversification.
Non-public alternative assets, like private equity or farmland, which are intended to be held for long periods in order to have a chance to grow over time, are also unlikely to fluctuate in value with every alarming news headline. This is another attractive feature for long-term investors.
On top of this, many alternative assets offer returns over time that are equal to, or better than, returns offered by the stock market. This is a secret that large institutional investors have been aware of for years. Yale University, the frontrunner in the field, has more than 75% of its portfolio allocated to alternative investments, and the majority of institutional investors surveyed by Nataxis earlier this year said they were interested in increasing their allocation to alternatives.
Examples of alternative investments
Alternative investments vary significantly in terms of minimum investment, investment horizon, liquidity, and risk and return profile, among other factors.
Some alternative investments, such as private equity or hedge fund investments, typically require minimum investments of $25,000 or more. When you invest in private equity, you are buying a (typically indirect) stake in a private company, whereas a hedge fund may seek to earn a return through various proprietary strategies, including investments in the public markets. Typically, both these investment types would be made through a fund structure with a minimum investment period of five or more years and restrictions on when investors can exit and have their capital returned.
Gold is a popular alternative investment. It is used as a store of value and a hedge against inflation and/or a weak US dollar. Investors can access gold in a number of ways, including buying bullion, buying an ETF that tracks the price of gold or buying gold options or futures. However, the accessibility of gold has some drawbacks: namely, the price of gold can be extremely volatile. Another drawback compared to other classes of alternatives is that gold is not a source of passive income.
Another popular category of alternative investment is real estate. Real estate is a broad sector, with multiple avenues for investment. Investors can gain exposure through direct investment, investing in a master limited partnership, purchasing a REIT, or using a crowdfunding or other online technology platform, among other ways. These vary significantly in terms of minimum investment amount, investment horizon, and liquidity.
Farmland: the newest-oldest alternative investment
One alternative investment that may be less familiar to investors is farmland. Despite being one of the oldest asset classes there is, farmland has long been out of the reach of average investors due to a lack of available infrastructure. Historically, the majority of farmland was family-owned, although a high amount of turnover is expected in the coming decades. This fact, combined with the advent of innovative investment platforms such as FarmTogether, is opening up new opportunities for accredited investors.
Farmland as an investment has offered returns comparable to the stock market. Over the past 20 years, farmland investments have offered an average annual return of ~10% and a positive return every single year. Farmland also can be a good investment in a recession. For example, in 2008-2009, the NCREIF Farmland Property Index was up 20%.
Benefits of adding farmland to your IRA
On top of these benefits, farmland has several characteristics that can make it a strong choice for your retirement portfolio. First and foremost, farmland is uncorrelated with stocks and bonds, meaning it adds favorable diversification to your portfolio. Farmland also experiences low volatility compared to stocks or real estate.
Important for long-term investors, farmland is a good hedge against rising inflation. The world’s population continues to grow, increasing demand for food, while the supply of US farmland shrinks each year. Thus, owning farmland allows you to own a real asset with intrinsic value that meets one of society’s fundamental needs.
Finally, farmland investing will be attractive to many investors focused on retirement because it provides an excellent source of passive income. In addition to appreciation of the underlying asset, which is realized when the investment is sold, FarmTogether’s investors receive the benefit of periodic lease payments from farmers and payments from the sale of crops.
Invest in farmland with your Alto IRA
For all these reasons, farmland may be just the asset class you need to round out your retirement portfolio. Thanks to AltoIRA, there is now a low-cost, fast, and easy way to invest your IRA in one of FarmTogether’s offerings.
To open an account with AltoIRA, click here.b