What Stock Market Volatility Can Teach Us About Portfolio Diversification

Stock Market Volatility and the Importance of Portfolio Diversification
With so much volatility in the markets, investors are right to worry. In this post, we talk about portfolio diversification and the importance of alternative investments.

If you’ve been watching the stock market even loosely, you know the headlines haven’t been good. April saw stocks continue to plunge, with the Nasdaq closing out its worst month since 2008, the S&P 500 marking its steepest one-month decline since March 2020, and tech companies like Meta, Netflix, PayPal, and Zoom all posting quarterly losses

Among investors’ growing list of concerns contributing to stock market volatility are the war in Ukraine, COVID-related manufacturing shutdowns in China and other supply chain issues, persistent inflation and the Federal Reserve’s aggressive plan for tackling it, a significant increase in home foreclosures, regulatory uncertainty, and mounting recession fears.

All of this spells trouble for Americans’ 401(k) accounts, many of which have already seen losses in excess of 10% this year. For those nearing (or in) retirement, this is particularly worrying—especially if analysts are right about projections of annual growth below 5% over the next decade.

So what can investors do to help minimize potential losses during times of considerable stock market volatility? And what can we learn from the current volatility in the stock market?

Portfolio Diversification Is a Must

We’ve all heard the expression, “Don’t put all of your eggs in one basket,” applied to investing. But what that means for different people varies considerably. 

If all of your investment funds are in target-date funds—often held in employer sponsored 401(k)s or conventional IRAs—you might consider that a diversified portfolio. These mutual funds hold a mix of stocks and bonds that is recalibrated to reflect the risk appetite fund managers recommend for investors generally based on their age and stated retirement time horizon. 

For those nearing retirement, a fund manager will typically prioritize lower risk (but often lower yield) investments. Meanwhile, younger investors’ accounts tend to skew toward higher risk assets with the potential for greater growth because they, in theory, have more time to recover from a crash. 

However, not everyone subscribes to this all-stocks-and-bonds approach. Many of the most successful investors—including the ultra-wealthy, investment banks, university endowments, and sovereign wealth funds—take a very different approach. 

Many View Alternatives As Essential to a Truly Diversified Portfolio

Rather than allocating nearly all of their funds to “traditional” investments—such as publicly listed equities, bonds, and currencies—ultra-high-net-worth investors allocate, on average, 50% of their investment funds to alternative assets, according to research by KKR, a global investment firm.

So while the average retirement portfolio might be composed of 60% stocks and 40% bonds—give or take, depending on risk profile and investment horizon—an ultra-wealthy investor might instead allocate 30% to stocks and bonds, 30% to private equity, 10% to real estate, and the rest to art, crypto, and private credit.* And that diversification gives them a big advantage. 

Not only do some of these investments offer the potential for outsized returns; spreading funds across a handful of asset classes helps to reduce the risk that significant declines in one asset class will bring down the entire portfolio. No wonder global asset management groups like Janus Henderson believe there’s a strong case for investors allocating more of their portfolios to alternatives, especially as stock market volatility increases.

Now that we’ve discussed the differences in the allocation strategies of retail investors compared to ultra-wealthy and institutional investors, let’s take a closer look at what alternative investments are and how to invest in them. 

*Important note: The investment breakdown listed here is solely for the sake of example and should not be considered investment advice.

What Are Alternative Investments?

Generally speaking, alternatives are assets that are not typically available in the public markets like stocks, bonds, currencies, mutual funds, and exchange-traded funds (ETFs). 

These include investments in: 

  • Startups, private equity, venture capital, and other pre-IPO companies
  • Residential and commercial real estate
  • Farmland and other land or mineral rights
  • Luxury items, like art, classic cars, sports memorabilia, and wine
  • Crypto assets and funds

Often, alternative investments are illiquid, meaning they can’t be sold whenever you wish. For this reason, shares of a private company are considered illiquid because they can’t be converted into cash until that company goes public or is acquired. Part of the reason these investments offer the potential for big returns is because of the risk you assume by investing in something that is illiquid.

Not all alternatives are illiquid, though. Cryptocurrency, for example, can be bought or sold 24/7 via exchanges. And others straddle the line between liquid and illiquid. Like shares of a painting that can be sold on a secondary market prior to the artwork going to auction.

Alternative assets also vary in their degree of correlation to public markets, which is why so many asset managers advocate for portfolio diversification. Crypto, which has also experienced a pullback from all-time highs, has become increasingly correlated with the S&P 500, meaning they tend to rise and fall together. Meanwhile, fine art, bonds, and investor-grade wine are less correlated, with some assets even moving opposite in times of stock market volatility.

For these reasons, cultivating a portfolio that includes a healthy variety of asset classes can help reduce the potential for significant loss.

How to Invest in Alternative Assets

Though just now becoming a part of the conversation, investing in alternative assets is nothing new. It’s just that these opportunities haven’t historically been available to most Americans. 

That changed with the passage of the JOBS Act in 2012. Short for Jumpstart Our Business Startups, the JOBS Act scaled back the reporting and disclosure requirements for small businesses, and allowed private companies to secure new sources of capital via crowdfunding—enabling everyday investors to participate in opportunities to invest in seed-stage and pre-IPO companies. Opportunities that, while risky by public market standards, have the potential for explosive growth seldom seen on stock exchanges.

Beyond investing in startups, the rise of fractional ownership has given way to countless platforms enabling investors to buy securitized shares of just about anything—from paintings by Monet or Warhol to Michael Jordan rookie cards, ultra-rare Rieslings and even shares of luxury apartments.

Today, you can even invest your retirement funds in alternative assets via what’s called a self-directed IRA. Like alternative investments, self-directed IRAs are nothing new. But prior to Alto, investing in a traditional, Roth, or SEP self-directed IRA was time-intensive, often involving mounds of paperwork and significant commitments of capital. 

Invest Like the Ultra-Wealthy Using Your IRA

Now, everyone has access to the same investment opportunities as the wealthy and well-connected—with the tax advantages of an IRA. In fact, investing in alternatives using an IRA just makes sense.

Because you can’t take penalty-free withdrawals until six months after turning 59, IRAs are the perfect vehicle for investments with long time horizons—as well as most Americans’ largest source of investment funds. You can even fund your investments by rolling over an old 401(k) or other IRA.

Open an Alto IRA or Alto CryptoIRA® to discover a world of tax-advantaged investment opportunities most people don’t realize they can access.