A well-diversified investment portfolio contains a mix of stocks, bonds, short-term cash investments, and savings accounts that is tailored to your investment goals and risk tolerance. If you want to diversify your investment portfolio further, you can look to other investment possibilities. Here are a few of these, with brief explanations of what they are, how they can be used, and what the risks and potential rewards may be.
Some investors purchase silver or gold as a hedge against inflation or currency fluctuations.
In general, as inflation rises, the value of the dollar normally goes down. Historically, when a significant drop in the dollar occurred, gold and silver (and platinum to a lesser extent) went up in value. Precious metals such as gold had a tendency to retain their purchasing power no matter how badly the currency declined. Precious metals have intrinsic value, while currency can literally become worth less than the paper it is printed on, as was the case with the German mark after World War I. Keep in mind, though, that past performance is no guarantee of future results, and there can be no assurance that an investment will ever be profitable.
As with any other investment, risks are involved when investing in gold. These include certain risks uncommon to other types of investments, such as monetary policy changes and currency devaluations. Investors should discuss the risks of investing in gold with their financial professional.
Some options for investing in precious metals include actually purchasing the asset (i.e., gold bullion or coins), buying shares of mining companies, investing in a fund that concentrates its portfolio in the securities of issuers principally engaged in gold-related activities, buying futures or options contracts (see below) or investing in an exchange-traded fund that holds bullion.
Options give the owner the right, but not the obligation, to buy or sell an underlying asset at a set price (strike price) before a certain date (expiration date). The underlying asset can be (to name some of the more popular ones) currency, a stock, an index, a bond, or a Treasury bill. A call option is the right to buy the underlying asset, and a put option is the right to sell the underlying asset. The price paid for the option is called the premium.
An investor purchases an option to control a specific number of shares for a limited period of time. An investor might purchase a call option because he or she believes that the price of the stock will go up during that period. Similarly, an investor might purchase a put option because he or she believes that the price will go down during that period. If the investor has guessed wrong, the option expires worthless and he or she could lose the total premium paid for the option.
An investor may sell an option for income on an underlying security that he or she owns. The income is the premium that an option buyer pays to purchase the option. If the underlying security moves in favor of the option buyer, the buyer may exercise the option, and the option seller may be required to sell the underlying security. If the underlying security moves in favor of the seller, the buyer normally will not exercise the option, and the seller keeps both the premium and the underlying asset.
These are just two strategies in which an investor uses options. Although there are many benefits in using them, options are risky and not suitable for all investors. For example, selling an option is done in a margin account, subjecting the seller to interest costs and margin calls. Before attempting to buy or sell options, it is important to discuss the role they can play in your portfolio with a financial professional. Options are not suitable for all investors; you may lose the entire amount of invested principal in a relatively short period of time.
A futures contract is a promise to buy or sell a commodity for a certain price on a future date. Commodities include oil, natural gas, lumber, and base metals, as well as many agricultural products such as farm grains, beef, pork, coffee, and cocoa. In addition to commodities, investors can trade futures on foreign currencies, interest rate products such as Treasury bills, precious metals, and market indexes such as the S&P 500.
Investors purchase futures contracts either as a hedge against price fluctuations or for speculation purposes. Hedging is the primary purpose of futures contracts. The purchaser of the futures contract establishes a price now for a purchase or sale that will take place in the future. Speculators buy and sell futures contracts based on whether they expect prices to move up or down; they hope to profit from the price changes that hedgers try to avoid, and rarely take delivery of the underlying commodity itself.
Futures contracts are extremely high-risk investments; as with options, investors may lose the entire amount of invested principal in a relatively short period of time. They should be considered only by experienced investors and professionals.
Real Estate Investment Trusts
A real estate investment trust (REIT) is a corporation (or business trust) that invests in real estate or provides financing for real estate. REITs own and, in most instances, manage income-producing real estate such as offices, shopping centers, apartments, and warehouses. REITs derive their income from rents and capital gains realized on the sale of real estate. Some REITs invest in mortgages secured by real estate and get their income from the collection of interest. A REIT may specialize in one type of real estate — for example, office buildings — or have holdings in a variety of types.
REITs offer a convenient way for an investor to participate in commercial real estate. First, an investor’s capital commitment is lower, since the investor buys shares of a REIT rather than the actual property. Second, owning a REIT generally offers greater liquidity than owning the property itself. Most REITs trade on the major stock exchanges and can be purchased or sold through stockbrokers. Finally, you get professional property management, which means you don’t have to chase after the rents or respond to late-night phone calls about maintenance problems.
REITs offer long-term growth potential and income. Also, investing in REITs helps diversify a portfolio, though diversification alone can’t guarantee a profit or protect against potential loss. However, risks are associated with real estate investing. The value of real estate is affected by interest rate changes, economic conditions (both national and local), property tax rates, and other factors. It is important to discuss with a financial professional the role REITs can play in your portfolio.