Today we talk about our extensions into alternative investments and diversifying your portfolio. Chris keeps asking about Gold and Silver so it's time we finally address that. When should you be diversifying? What types of options do you have? Why is an alternative investment important in the first place? All of these questions and more get addressed here!
Please feel free to go back and re-listen to some of our previous episodes. This will help with some of the foundations here if you would like to have that base. Chris had to.
Today we talk about our extensions into alternative investments and diversifying your portfolio. Chris keeps asking about Gold and Silver so it's time we finally address that. When should you be diversifying? What types of options do you have? Why is an alternative investment important in the first place? All of these questions and more get addressed here!
Please feel free to go back and re-listen to some of our previous episodes. This will help with some of the foundations here if you would like to have that base. Chris had to.
This is the truth about investing back to basics podcast where we want to help you take control of your personal finance and long term investments. If you're looking for a way to learn the why and how of investing then you found the right place. Thank you for taking the time to learn how to better yourselves. button is pushed el pushedo. As the French would say.
Sean Cooper:Right.
Chris Holling:Checking 1
Sean Cooper:2
Chris Holling:3
Sean Cooper:I think we need to work on your French
Chris Holling:eins, zwei, is that the French
Sean Cooper:Going to jump over to German, huh. now my mom would be very disappointed and she her French isn't even that good anymore.
Chris Holling:Well as long as as long as she can be disappointed for my not even elementary level. French
Sean Cooper:Un, deux, trois
Chris Holling:what is that cat? Quatre, cinq, six, sept, huit, neuf, dix. That's it. That's all I got. I'm out. I'm out of un. iens, no. There it goes again.
Sean Cooper:Did you jump back to German again.
Chris Holling:I did.
Sean Cooper:Were you in German the whole time?
Chris Holling:Uns
Sean Cooper:Yeah, you were in
Chris Holling:that's that's what happened is I was gonna say uns and then I went iens sept. it's whatever. It doesn't matter
Sean Cooper:how little foreign language we really know or speak. It's rather sad
Chris Holling:Well. I mean, what I know the best is sign language. And that's not exactly something I can demonstrate on a podcast.
Sean Cooper:No, go ahead, Chris. It'll be really entertaining for everone.
Chris Holling:Okay. Okay, here here. I'll sign to you. I signed.
Sean Cooper:Nice job. Nice job.
Chris Holling:Thank you.
Sean Cooper:That was fantastic.
Chris Holling:Yeah, I appreciate that. I asked how you are, by the way, I know, I know. You couldn't tell that.
Sean Cooper:I'm pretty good.
Chris Holling:Because you don't understand sign language.
Sean Cooper:I'm even better now. Oh, that's why I couldn't tell
Chris Holling:Yeah, that's why you couldn't understand that. That's what happened. Okay, whatever, we should introduce things. Welcome back, everybody, ladies and gentlemen, to the truth about investing back to basics, not how to learn a foreign language.
Sean Cooper:Clearly,
Chris Holling:my, my name is Chris Holling.
Sean Cooper:And I'm Sean Cooper.
Chris Holling:And today we are going to talk about alternative investments. Right, Sean?
Sean Cooper:Indeed,
Chris Holling:okay, he had to correct me because I put little notes on how to remember that we're talking about alternative investments on here. And he said no, that's not all we're talking about. So.
Sean Cooper:Chris just wants to talk about gold and silver.
Chris Holling:I do I want to talk about the metals. And I and and aluminum should we invested in aluminum
Sean Cooper:not among the precious metals that most people would buy into, but it's a you know, certainly an industry you could buy into I suppose
Chris Holling:Well, maybe not a bunch of people are into it yet. is what I think that's what it is.
Sean Cooper:That could be
Chris Holling:a trendsetter.
Sean Cooper:It is a unique metal, that is for sure.
Chris Holling:Well, okay, so I know that it will fit in there. Because I am I am interested to, to learn a little bit more about that. But like, Where Where does that land? Do we do we open up with some some precious metals perhaps?
Sean Cooper:Well, I was thinking maybe we should discuss why we're talking about alternatives in the first place kind of tie into some of our prior episodes. Specifically, we're talking about alternatives because of that diversification that we've been talking about in the past and the correlations. So adding in alternative investments to the portfolio can help enhance the portfolio in a number of different ways, either in improving return or reducing risk or some combination of those two, but really allowing you to tailor the portfolio to your risk and reward profile based on your risk tolerance, financial ability to assume risks, that sort of thing. Because strictly sticking to stocks and bonds, really doesn't provide the same diversification benefits that it used to when modern portfolio theory originally was devised.
Chris Holling:Okay.
Sean Cooper:So yeah, I was going to basically present some of the alternative investments that are available out there and discuss why they can potentially help a portfolio or where they might fit in.
Chris Holling:Well, I have a question about that. And maybe maybe this is me kind of jumping ahead. Maybe not but when when we were looking at these the the alternative investments that you have not listed yet. Is there a point when you start to say, now is the time to start considering these things as opposed to the stocks and bonds stretch like you're referring to? Or is it more of a fluid option than that? Like? I don't know if I asked that very well,
Sean Cooper:no, that no, it's a good question. Assuming I understand what you're getting at, is there a time to get in or get out of alternative investments? And my answer to that is, if there was, if you somehow have a magical bell that goes off to tell you when the markets going to tank, then yes, there would be a time to get in and out of alternative investments. And realistically,
Chris Holling:I need to get me one of those
Sean Cooper:yeah, yeah, you and me both. Realistically, if there was somebody who actually knew when that was going to happen, consistently, I should say, even if they knew it once, they'd be very wealthy. You look at The Big Short, if you've ever seen that movie, or read the story,
Chris Holling:I haven't but it sounds like it's time to
Sean Cooper:the original person who basically predicted 2008
Chris Holling:Oh, ok
Sean Cooper:Yeah, and he was wrong for months. And he nearly lost everything in the process. And then when it did happen, and he proved to be right, he made tons and tons of money for himself and his clients.
Chris Holling:Wow.
Sean Cooper:Okay, and that's because he predicted it once. Could he do it again? Maybe Maybe not. Because the cause for market crashes varies each time. Now, there are some some commonalities but the the overarching cause and what like he predicted in 2008 is not the same. So actually being able to see the entire market and go Okay, this is going to be the cause and this is when it's going to happen because even he didn't get it right in terms of exactly when it was going to happen. Like I said, he almost lost everything. Waiting for it to actually happen so
Chris Holling:well, in part of that's because when you have things like, 07' 08' occur, then new things get placed in new things get put in place to help avoid that from happening is the point
Sean Cooper:oh, you brought in a whole nother topic there. You're talking about government regulation that didn't work to begin with, and they made worse in there... oh, that's a that's another t pic that we really need to disc ss. Because, oh,
Chris Holling:we can we can have a different episode
Sean Cooper:That one I'm a little fiery about
Chris Holling:I was mostly just addressing that when you are going, Oh, this, this could happen again. Even if things get shuffled around, and you're just you know, robbing Peter to pay Paul to fix something else. It's still not likely for that crash to happen for the same reason cuz new things are in place
Sean Cooper:Hint, hint, they didn't fix anything,
Chris Holling:Shut up. That's a different different episode. Or it's about to be I have to I have to put it in here.
Sean Cooper:Yeah, you do need to put that in.
Chris Holling:Instert that in. Yeah,
Sean Cooper:yeah.
Chris Holling:Here I go. I'm, going to enter it in now.
Sean Cooper:No but my point is the cause of market crashes. Very, I mean, look at 2008 versus 2001. Tech had nothing to do with 2008. But it was everything to do with 2001. That was a tech bubble.
Chris Holling:Right
Sean Cooper:Whereas 2007 2008 was the mortgage crisis.
Chris Holling:Correct
Sean Cooper:Okay, I just so completely different things that actually caused the crashes, we know there's going to be crashes, that's it's going to happen. They'd like to pretend they can avoid it. Realistically, I think they're going to make them worse.
Chris Holling:Probably,
Sean Cooper:but it's going to happen. It's just a matter of when and why. So my point being in all this, I don't think anybody is going to consistently predict each and every market crash when and why it's going to happen.
Chris Holling:Right
Sean Cooper:So trying to get into or out of alternative investments at a particular time is going to be very, very difficult, if not impossible. So my point is, you should probably add in alternative investments to your portfolio permanently to some degree.
Chris Holling:Okay, that makes sense. I could see that.
Sean Cooper:Okay. If we use 2008 as an example, many people assume that in 2008, everything went down because most people lost lots and lots of money in 2008. We're talking about the market going down. I think the worst point was like 39%, something along those lines, most people it was closer to, you know, 30 35%, that they may have lost in their portfolios, especially on the equity side. But in that time bonds, for the most part also lost money. And so people just assume that 2008, everything lost money. And that's not true. And that is, I think, the easiest illustration of why alternative investments can be advantageous. So you have some, pretty much the only traditional asset classes that even broke even in 2008 that most people had access to, would have been like the BAR Barclays aggregate bond index, so I'm just using kind of broad asset classes here. Foreign corporate bonds actually basically broke even the only thing that most people probably were invested in or had access to that did that actually had a positive rate of return in 2008 would have been long term treasuries.
Chris Holling:Oh, okay. Like I said, what, when you say treasuries, plural, like, do you? Do you have an example of some treasuries or
Sean Cooper:Treasury treasuries, meaning US Treasuries, bonds, notes?
Chris Holling:Okay, sorry. I thought that's what you meant. I just
Sean Cooper:yeah,
Chris Holling:I didn't know there was some Walmart Treasury?
Sean Cooper:No, no, nope, in fact, yeah. corporate bonds, US corporate bonds really didn't do very well, high yield bonds really got hurt. So yeah. But that's where the alternatives come into play. And see, when you talk about alternatives, some people might dabble. And they would consider like real estate an alternative asset class. And I would agree that is an alternative asset class. It is among the alternative asset classes that did really, really poorly in 2008. Because it was a mortgage crisis.
Chris Holling:Sure, yeah. That makes sense.
Sean Cooper:However, things like gold, silver, private equity. If you invested in volatility, and managed futures, which are other alternatives, all did really well in 2008.
Chris Holling:Okay,
Sean Cooper:but most people are not invested in those things. And that's why having those mixed into your portfolio Can you know, enhance returns or reduce mitigate risk? Do you want me just to start jumping into some of these, and we can talk about them?
Chris Holling:Yeah. Well, I mean, sure. When I think when I think of an alternate investment, or alternative, alternative investment, really, I jump to precious metals, and I imagine a lot of people do, as well. And I'm not trying to continue to go back and harp on I really was just giving you a hard time about it.
Sean Cooper:No, I don't mind certain there.
Chris Holling:No, I just think that that's that's something that's commonly known as an option that's readily available to people and and towards the top of their minds. Like, when you refer to the the first set of bonds that did well, in the, in the O7' 08' stretch, I was like, yeah, sure that that bond, of course, everybody, everybody knows about that bond. So So I, you know, as far as like ground level stuff, I would think like, yeah, this this is stuff that is almost in common conversation, that is an alternative investment that that you could consider, and here's why. And, and then, past that point, like, I think it's all noteworthy, so yeah,
Sean Cooper:yeah, um, so yeah, but before I jump into the metals, let me actually make it a quick distinction here. When looking at alternative investments, I divide them into two subcategories. So alternative assets, and alternative strategies. So alternative assets would be things like hard assets, things you can physically see touch, smell, that sort of thing. alternative strategies being unique investment methodologies.
Chris Holling:Do you do you smell your metals?
Sean Cooper:I mean, not inttentionally
Chris Holling:If you can touch it and you can smell it. I mean, you just, you said if you can see it, and you smell it and touch it, and I just wondered if you got a hold of your metals and smelled them.
Sean Cooper:No, I'm not Scrooge McDuck.
Chris Holling:I'm gonna start smelling my metals. Sorry,
Sean Cooper:you should
Chris Holling:continue
Sean Cooper:You should. Okay. So alternative assets, the things you can see touch. I guess you could taste them and smell them if you want. I, I use those, or I view those as alternatives to equities because they tend to be higher risk and higher reward. So they tend to perform like equities but non correlated, so it potentially can enhance the portfolio whereas alternative strategies tend to have risk and reward profiles more similar to fixed income, bonds. And so I use them as a bond alternatives. So I break those two categories out. So addressing the alternative assets, we have your metals, real estate, global natural resources, and private equity basically. So jumping into the metals, the ones most people know and are aware of are gold and silver. You can also invest in things like platinum, palladium, copper, I guess you could probably invest in aluminium
Chris Holling:aluminium.
Sean Cooper:I guarantee there's a futures market for it. I just don't know many people that do
Chris Holling:Not yet.
Sean Cooper:Yeah. There's a couple things to be aware of. I think people tend to refer to gold as a safe investment and silver maybe to a lesser extent, the The truth is gold as an asset class that the price of gold is actually more volatile than the s&p 500.
Chris Holling:Oh, wow, I didn't know that.
Sean Cooper:Yeah, so I would not classify as safe a hedge Yes, because gold traditionally has done well against inflation it's done well against. Well, inflation to a lesser extent it's kind of matched inflation, but it's done very well in bear markets, market crashes, people tend to revert to gold when they are fearful of the the general market. So stocks.
Chris Holling:So
Sean Cooper:additionally, it's worked well as a hedge against or people view it as a hedge against issues with the US dollar. If you're investing in if you live in the US and you're using US dollar predominantly.
Chris Holling:Well I might be getting ahead of myself here, but when you're when you're talking about that, and you're comparing it to to a hedge then say say I am that magical person that that does know that the crash is happening tomorrow, then the gold would sit as a better hedge overall for that crash in particular, as opposed to the s&p comparatively but overall if it if you're looking at like a, you know, let's say a 10 to 30 year range, if you sat on the S&P and then you then you rode that crash, it would probably do better than the gold long term. Is that is that what I'm understanding?
Sean Cooper:Yeah, yeah, more or less. I mean, if you have that magic Bell, then you should probably just short, the s&p 500. And forget investing in gold in the first place. But
Chris Holling:Dang, it, you're so smart.
Sean Cooper:But yes, gold would be beneficial for that crash, long term rate of return on gold is not going to most likely beat the s&p 500 if you just buy and hold.
Chris Holling:Okay.
Sean Cooper:But again, that's why it's designed as a piece of the pie to smooth out that ride over time.
Chris Holling:Okay,
Sean Cooper:same scenario with silver, but to a lesser extent.
Chris Holling:And so in theory, you aren't smart enough to short something because we're talking about me instead. And we're not smart enough to short that. Nevermind. Anyways. So I hedge it with the gold, this, this crash that I'm foreseeing and then because I hedged it I, I survived that crash significantly better than others might. And then now that the s&p has dropped, then I use my hedge to purchase s&p while it's low.
Sean Cooper:Yeah, the easiest way to go about doing that without having a magic bell would be to practice periodic rebalancing. So if you say, I'm going to put 70% in traditional asset classes, 30% in alternative asset classes, I bring that up, because that's how I traditionally do it. Most people are more like 90%, traditional 10% alternative and that's oftentimes because they're not familiar enough with alternatives. Back offices are scary of alternatives, even though the math works out to be much better for the investor the other way, but anyway, that aside, say it's So say you're the traditional, traditional investor and your 90/10 90% tradition, traditional asset classes, 10% alternatives. So you've got and we'll just use the s&p 500 and gold for the example 90% in the s&p 500, 10% in gold, I'm not advocating that portfolio for reference.
Chris Holling:Right. Okay, I gotcha.
Sean Cooper:As the market does well, over time, your portfolio is going to get to a point most likely where you're looking at more like 95% s&p 500, 5% Gold just because the s&p 500 has outpaced the gold. If you rebalance periodically, you rebalance to that 90/10. So you end up automatically it forces you to sell some of the s&p 500 when it's high, and buy some of the gold when it's low. And then as the market corrects and you know we have those those corrections, all of a sudden we get that that swing and the s&p 500 does really poorly, the and gold outpaces so your portfolio's now 80% s&p 500 and 20% gold. So you rebalance again, and it forces you to sell gold when it's up. And buy s&p 500 when it's down. So no magic Bell, just rebalancing forces you to do what you should already be doing, instead of what most people default to doing, which is the opposite.
Chris Holling:And then from a professional standpoint, from your side, I understand your your 70%, traditional 30% alternative approach that you prefer right to this
Sean Cooper:Yes,
Chris Holling:Did I say that right?
Sean Cooper:Yes.
Chris Holling:Do you do that across the board for like, all the different realms that you offer? when you're when you're offering like non qualified accounts and, and etc? Or do? When somebody contacts you for your business? Is it? Hey, I do stuff to Hey, Sean, do magic with my with my money? Do you do that 70/30 as a whole overall? Or is it only to certain accounts that that you offer Where? I'm just I don't even know if I'm going to keep this? I'm just curious. Yeah,
Sean Cooper:No, that's okay. Yeah. So it would have nothing to do with the type of account whether whether it's qualified or non qualified. Okay. But to answer your question, yes, I blanket, all accounts end up roughly that 70/30 what what differs is the blend of the the assets. So, I mentioned earlier, that idea of the alternative assets versus alternative strategies and them being similar to equity versus similar to bonds. So a more aggressive portfolio is going to have a much larger percentage of the of that 30%, a larger percentage is going to be in alternative assets and a smaller percentage in alternative strategies, whereas a more conservative portfolio will have a smaller percent and alternative assets and a larger percent and alternative strategies.
Chris Holling:Okay. Okay. That makes sense.
Sean Cooper:Yep. No, good question. Oh, well, I guess we should cover how to invest in metals.
Chris Holling:Oh right, how do I do that, Sean
Sean Cooper:Regardless of the type of metal that you're, you're buying. So there's a number of ways to do it. The first would be to utilize a fund. So a mutual fund, an exchange traded fund, that would be the easiest way to go about it, you're going to get access to the what the market deems is the the price if you will, or more specifically, how the fund is performing, because it's not a perfect tie there. So investing in the fund is the easiest methodology of the methodologies that we'll discuss, it probably gives you the least amount of diversification because it's not a perfect tie to the price of the underlying metal.
Chris Holling:But what if you just want to feel like a pirate? So you prefer the coins? You know?
Sean Cooper:Well, we'll get to that. I will say,
Chris Holling:those are my coins for reference Yar we be invested in the best way that we can.
Sean Cooper:Yeah, the in when you invest in the funds, there are different types of funds that do it. And I tend to prefer the ones that actually hold physical bullion. So they actually for everybody that invests in their fund, they actually go out and buy the bullion, you don't hold it personally, they hold it themselves, but at least there is physical bullion backing your investment, whereas a lot of them do not. So you're just hypothetically investing in it.
Chris Holling:Interesting. Okay, that makes sense. I just never would
Sean Cooper:They use leverage and a variety of other things that oftentimes it's going to be futures and things of that nature. So that's something to be to consider, especially if you're using it as a hedge, the closer you can get to the physical bullion, the better.
Chris Holling:Okay, yeah, that makes sense.
Sean Cooper:Which brings me to the next which would be to invest it in your portfolio and then have someone else hold it for you. If you don't want it to be at your, you don't want it to be shipped to you, you don't want to hold on to it. There are different banks and stuff that will actually hold it for you. Many IRAs, they have a system where they'll set it up and they set up basically a lock box that you don't actually know where it is or hold or have anything to do with but it's technically there for you, representing what you hold. So that would be a step closer, and then The last would be you actually buying the physical bullion and holding it yourself or depositing it into a bank near you. And as I said, as far as a hedge is concerned, the closer you can get to the physical bullion, the more it acts as an actual hedge because you're dealing with the true price of the bullion not what the market does. Because if you look at things like 2008, again, even though gold did well so did silver in 2008, the funds that represented golden silver did not do as well as the precious metal itself, because people tend to panic. And they sell everything all at once, regardless of its underlying value. So even if the mutual fund or ETF that you invested in for gold and silver, even though the underlying asset class, the underlying commodity did well, the price of it did well, your value did well. The price of the ETF or the mutual fund did not do as well, because people panicked and sold it even regardless. So
Chris Holling:right.
Sean Cooper:Does that make sense? Okay,
Chris Holling:no, it does. It does. I, I was I was totally just jingling coins at you just because I thought it was funny. But
Sean Cooper:oh,
Chris Holling:well, this is still back from when I sold that truck for silver coins. And I was just like, Oh, I guess I'll hang on to these. And I still feel like a pirate every time I open this drawer that just sits there. But
Sean Cooper:Yep
Chris Holling:I mean, yeah
Sean Cooper:And there's lots of ways you can invest in like silver, for example. You've got the pre What is 1986? (64')
Chris Holling:Yeah.
Sean Cooper:Silver dollars that were actually 90% silver, and then you've got actual coins or
Chris Holling:you can get little silver bars too
Sean Cooper:Yeah, or bars? Yeah.
Chris Holling:I mean, there ity bitty there like one ounce or whatever, but
Sean Cooper:and then you can get into the debate of Do you want just US minted silver and gold, which is going to be sold at a premium, but it's the only one the US government will technically accept? Or are you comfortable buying? You know, Canadian Maple Leafs are Australian. Africa is another big minter
Chris Holling:I just I just want to, I just want to get to the Ron Swanson stage is all I want. Just how much money do you have? I can tell you how many pounds of money I have.
Sean Cooper:If you have pounds of gold, you're you're sitting pretty happy right now. Yeah. All right. Does that does that that sate your your desire to discuss bullion?
Chris Holling:I think so mostly?
Sean Cooper:Mostly?
Chris Holling:Yeah, it does. Because I, you know, I that was something I considered as a as a Is it is it best to, you know, oh, I I'm going out and I'm getting hold of this in my hands or somebody is representing this for me too. And I think it covers a lot of spots. So that's, that's good.
Sean Cooper:All right, so another alternative asset, we talked about real estate, I would argue it's becoming more and more traditional. However, it does still offer some diversification, lower correlation to your traditional asset classes. And there's lots of ways again, you can invest in it, be it, you know, REITs, real estate investment trusts, or directly buying into it, and then you know, being a landlord or something along those lines. So and then you've got the difference between commercial real estate and residential real estate and the different rents associated with those or whether you're going to be you can be a fix n' flipper. There's all sorts of different ways to invest in real estate. But it does tend to perform a little bit different than the rest of the market, with the exception of periods like 2008, where it was part of the cause of the crash so
Chris Holling:well, and I might be splitting hairs here, but I would, I would think that the corporate real estate, unless you're
Sean Cooper:commercial,
Chris Holling:you're really sorry, thank you commercial, unless you're really fronting that, the entire process of all of that that tends to fall more into a traditional thing like you're talking about because it's several shares of a like a conglomerate all coming together to put that together.
Sean Cooper:for commercial real estate, unless you have very substantial portfolio, you're most likely going to do it through a REIT. So a real estate investment trust.
Chris Holling:Yes. Which is like, yep, okay. I was just mostly saying that it seemed more traditional for to me to be involved in something like that, like a trust or something like that as opposed to alternative but I am splitting hairs, maybe. Possibly.
Sean Cooper:Maybe it I guess it's going to depend on the the period? Because, yes, if the market crashes and businesses do poorly, then they're more likely to vacate their their commercial real estate, and then you lose the rent. So yes, I could, I could certainly see that. But then there's also the the trickle down effect of renters that, you know, if they lose their job and their ability to pay their rent, so it you know, it all kind of ties together eventually, it's just a matter of, at what level so
Chris Holling:yeah, that makes sense
Sean Cooper:the the renting tends to be fairly resilient. People still want a place to do business, people still want a place to live. So
Chris Holling:right?
Sean Cooper:Yeah.
Chris Holling:I mean, it all makes sense. I was, I think the numbers were all weird in my head.
Sean Cooper:No, I can, I can see where you're coming from, though. Absolutely. Moving on. From there, we've got global natural resources. And I'm just going through some of the ones that I tend to focus in on, there are other alternative assets, other alternative strategies, but we'll just go through the ones that I tend to focus in on so global natural resources would be another. So you're looking at, you know, technically speaking, your bullion is a global natural resource. But in this I'm looking more at things like timber, oil and gas, your rare earths that they use in, you know, batteries, cell phones, solar panels. anything along those lines. So
Chris Holling:??
Sean Cooper:you can focus in and do renewables versus non renewables, and, you know, go down one of those paths, what have you, but all of these, again, they, they have ties to your traditional asset classes. Certainly, you look at timber, for example.
Chris Holling:That's got to be doing well, right now. It has to be,
Sean Cooper:it's actually starting decline right now. It was doing really well earlier. I mean, prices were absolutely insane. For timber earlier in this year, they still are, but the prices that the they're they're starting to struggle, because a lot of the timber industry has gotten bloated off of the high prices they got previously, so
Chris Holling:gotcha, okay.
Sean Cooper:Yeah. But what I was getting at is, you know, if the demand for housing or construction and things of that nature goes down, then obviously, timber suffers. So that does have some ties to the market, but for general purposes, people still building stuff. So it offers, again, some level of diversification, depending on what natural resource you're getting into.
Chris Holling:Right?
Sean Cooper:Last one would be private equity. And although, you know, technically speaking, you it doesn't fit the see feel touch perspective quite as well, but it still falls into that category. So private equity would be anything that's not publicly traded any, you know, companies that are not publicly traded. So it's not your traditional equity class. They haven't gone public yet. They haven't done an IPO an initial public offering. And they're there tend to be very closely held. It gets back into that what we talked about previously with Chris and his venture capitalists,
Chris Holling:Hello
Sean Cooper:experience Yes. So private equity equity, we're either dealing with startups, very new businesses that are trying to get going, or businesses still fairly early stage, but they're trying to grow, they haven't gone public, yet, these ventures tend to be much higher risk, but also higher potential reward. So higher chance that they completely go belly up, and you get nothing back, but higher chance that they give you a much higher return on investment. And so you look at again, I bring up 2008, because it's our most recent example of how this might look. Maybe I started this the wrong way. But most investors as I talked about, maybe 90%, traditional asset classes, maybe 10% alternatives, if they have any alternatives in their portfolio at all, and that's probably real estate if they do. But you look at the big endowments like the Yale and Harvard endowment, and going into 2008 60% of their portfolio was in private equity. That one asset class
Chris Holling:Oh, wow
Sean Cooper:and, it's varied since then it's gone up. I think as high as like a 80% or more. And, but for the most part, it doesn't really go much below that 60% mark. So they have very high amounts invested in private equity. The issue with private equity, aside from its high risk is it also tends to be very illiquid, meaning you buy into a company, there aren't going to be a lot of other people that will buy you out of that company down the road until they go public, or until they have some kind of large liquidity event where they they sell the entire company or something along those lines. So it tends to be very illiquid, unless you get into funds that invest in private equity. But the advantage being again, that the potential for higher returns, but also its diversification benefits. So in 2008, when everybody else was losing their shirts, Yale, Harvard, their endowments, made lots of money. And that was because of their investments in private equity. Why? Because in 2008, a lot of the things that lost money from a valuation standpoint did just fine. The only reason they lost money in 2008 was because people panicked and made irrational decisions. Now there is some trickle down, obviously, that those investments, the underlying value did suffer to a degree, but not to the degree that people made it look like from the investment standpoint because of their panic selling. So private equity was largely immune to that to that because your average investor who panicked wasn't invested in private equity, so it didn't tank the way everything else did. Those private firms actually did just fine in 2008. Now, take that another year forward, 2009. And eventually, the markets did catch up to those private equity investments, and they hurt suffered in 2009. So they lost money in 2009, when the general market was doing really, really well. But again, that just lends credence to the idea of investing in multiple of these asset classes to try to smooth out the ride.
Chris Holling:Yeah, that makes sense. Okay,
Sean Cooper:cool.
Chris Holling:And then I guess, do, I was trying to think if there's like a I was gonna say, a layman's person, but really like a Chris's person's version of a private equity. That might be that might be common conversation that you like how we were saying earlier? Oh, well, gold and silver is common conversation, what what would a common conversation private equity be?
Sean Cooper:Typically, you're going to be looking at, again, mutual funds. There are some ETFs out there, but I don't think they do a great job of tracking the private equity market. There are some decent ones, there are some decent ones,
Chris Holling:okay.
Sean Cooper:But it just becomes a little more challenging the issue with so I still think private equity even in mutual fund or ETF form provides some diversification benefits. The issue is because, you know, on the plus side, they add liquidity you can get in and out of those mutual funds and ETFs more or less as you please, some of them do have lockups, but for the most part, you can get in and out whenever you please. The issue is that liquidity also allows for that panic, selling, buying and selling that we saw in 2008. So it tends to perform, those investments tend to perform more like the general market. There are still some diversification benefits there, though. To truly benefit again, it works like the gold and silver, the closer you can get to the actual investment itself, the more the diversification benefits work. So but obviously the more illiquid, they become so as you work your way closer, the next step would be a an actual hedge fund. The issue with investing in an actual hedge fund is most of them have minimum investments of say,$100,000. Plus, you have to be an accredited investor, which means either having some kind of designation, like what I have, or I think you have to have, like $5 million net worth of like $5 million, or have made maybe 1 million, it might just be a million. I need to look it up
Chris Holling:oh, just a million okay. Yeah, yeah, no problem.
Sean Cooper:Yeah, well, or have made I think 250,000. At the end, I should look this up because I think they might have changed it, the requirements for accredited investor. All right, net net worth over a million dollars, or an income of over 200,000 as an individual 300,000 for joint for the prior two years and a reasonable expectation of making that in the future. So otherwise You probably can't invest in a hedge fund anyway,
Chris Holling:gotcha. Okay,
Sean Cooper:next level down would be direct investment in private equity. So actually, you know, becoming like a venture capitalist, and going out and buying into a new company, or a company that's still fairly early in the phase that hasn't gone public yet. So you're actually, you know, giving them your money they're taking it investing in the growth of the company, and you're hoping to get your you become an owner of the company, and you're hoping to get a payout from that eventually?
Chris Holling:Sure.
Sean Cooper:So
Chris Holling:yeah,
Sean Cooper:yep. That covers the alternative assets that I wanted to go over. Any questions on those?
Chris Holling:No, I think that that went pretty well, actually.
Sean Cooper:Cool. Then let's talk about alternative strategies, which, like I said, are more akin to your fixed income side of your portfolio, you know, a little less volatility with one exception. And typically speaking, a little bit lower rate of return. So these are instead of being, you know, hard assets, for the most part, they are unique investment methodologies. So they may still buy into stocks and bonds, but in different ways. So an example of that would be merger arbitrage. So arbitrage is probably something we should have defined previously, if we haven't already.
Chris Holling:Oh, wait, no, that's, that's where I come in. Hold on.
Sean Cooper:Okay.
Chris Holling:Arbitrage. Did I spell that right.
Sean Cooper:A R B I T R A G E
Chris Holling:I totally spelled that right.
Sean Cooper:Nice.
Chris Holling:Look at me. That's, that's, that's awesome. Mm. Hmm. arbitrage is the simultaneous purchase and sale
Sean Cooper:Yep of the same asset in different markets, in order to profit from
Chris Holling:Did that do it? tiny differences in the assets listed price. It exploits short lived variations in the price of identical or similar financial instruments in different markets or in different forms.
Sean Cooper:Yeah, that would be the strict form of arbitrage the true form of arbitrage. arbitrage in its most oh, what's the word for it?
Chris Holling:I don't know I did my part most
Sean Cooper:most pure form is involves zero risk.
Chris Holling:Oh,
Sean Cooper:so like you said, Your this place over here is selling something for say $49 and this place over here is buying it for $50. So you jump in as the middleman and go Yeah, I'll buy it from you for 49. And sell this guy for 50.
Chris Holling:I've seen some couponers do the same thing. Extreme extreme couponers are just extreme arbitrageouns?
Sean Cooper:Right, right. So for the most part, arbitrage in that pure form does not exist anymore, it has largely gone away due to the technology that we deal with in the investment markets. And those those price discrepancies basically no longer exist. If they do exist, we're talking about hundreths of a second that only the most powerful computers can really take advantage of.
Chris Holling:Wow,
Sean Cooper:so for the most part, that doesn't happen. Most people use arbitrage a lot more liberally at this point and deal with things that can generally provide a lower risk return not riskless, but lower risk. So when we're talking about merger arbitrage, we're dealing with the fact that the majority of the time the purchaser in a merger so the company doing the acquisition, the buying tends to perform poorly initially, because oftentimes they are overpaying and the company being purchased tends to perform well leading up to the acquisition. So they will typically short the purchaser, and so sell the sell the stock of the purchaser and buy the stock of the seller, if that makes sense and therefore try to arbitrage that common discrepancy in performance going forward based on that merger. Now, they could also be basically just buying into a company that looks like a strong acquisition in the future in hopes that they will be bought and they will take advantage of that, that that purchase. However, that relationship doesn't always hold. That's why it's not riskless. In fact, the merger could completely fall through in which case those stocks your Your positions cou d completely Swing, swing wil ly on you and go the opp site way. And you could lose a l t of money. So it's arb trage in a loose form. But tha's basically what it is. The bea ty of string, you know, dif erent investments like this is ecause you're going long and sho t on different companies, the overall performance of the mar et doesn't have as much of an mpact on your overall inv stment. As long as there are mer ers going on, you can still ben fit from this investment sty e, even if the market is goi g down. With that said, mer ers, the merger activity, mer er and acquisition, m&a act vity, mergers and acq isitions tend to peak about the same time the market does, and they tend to go down when the markets crashing, but they do till occur. So there are sti l opportunities to take adv ntage of that. Questions on tha one?
Chris Holling:I don't think so.
Sean Cooper:Okay, another and this is the one that does not follow the general pattern of being lower risk, per se. And that would be volatility. So actually investing if you've heard of the VIX, which is a volatility index. So you're, it actually utilizes futures to try to take advantage of the volatility in the markets. So it's not an true investment in any logical form. It's you're not buying an asset, per se, you're you're betting on there being more volatility in the markets in the future.
Chris Holling:Okay,
Sean Cooper:the nice part about this type of strategy is volatility tends to peak as the market starts to crash. So it acts as that the hedge that we're looking for in a bear market. With that said, as the market is going up, oftentimes, volatility tends to be low and trail off. So over an extended period of time volatility actually tends to have a negative rate of return.
Chris Holling:Dang. Okay,
Sean Cooper:yeah. So it has it's a fairly substantial disadvantage. But it also has one big advantage of being a direct offset to market crashes. I've heard it described as well, I should say the reverse of it, I've heard investment. There are in investment options out there that basically do the opposite. So they, they essentially, sell volatility. And they've been described as picking up dimes in front of a steamroller. Because you're basically just getting little bitty premiums all the time for the fact that you're selling you're basically selling options. And so you're getting these little premiums all the time for the fact that the markets not doing anything crazy. But then when the market does do something crazy, you get steamrolled.
Chris Holling:Well, I, that's, I, that's a hard visual to forget.
Sean Cooper:So but again, and that that's not a that'd be on the opposite end of the volatility, investing. It's the opposite of what I'm actually trying to describe here. So it's very legitimate investment option. It's just not what I'm discussing. It'd be the opposite end of what I'm discussing at this point,
Chris Holling:right
Sean Cooper:Yeah. questions on that? Because I know that's kind of an arbitrary
Chris Holling:No, I mean, I don't know how to how to say this very well. But I, I feel like if you're going to venture into that realm, that's much more of a call call call Sean and, and discuss the different possibilities if you want to go down that road rather than make the decision based off of this loose description here type type thing. So like, I don't know
Sean Cooper:it's just it's an it is an odd one. So yeah, cuz you're not investing in something really tangible it's and a lot of these are going to be based on futures as is the next investment that we're talking about. So but at least those futures have something tangible behind them whereas volatility doesn't you're you're really just investing in futures of the market itself. And it's it's kind of strange, so yeah,
Chris Holling:okay.
Sean Cooper:And honestly, we haven't even discussed futures. But we we should put that down as a future
Chris Holling:future
Sean Cooper:topic
Chris Holling:future. Where Where does that go? So I don't forget.
Sean Cooper:Do we have derivatives on their
Chris Holling:derivatives at the end?
Sean Cooper:Okay, so remember this episode? And if you have questions on futures, we will address them eventually. Sorry, we haven't already
Chris Holling:futures in will occur. And in the future
Sean Cooper:derivatives, yes. We'll talk about futures in the future. All right, which brings me to the next alternative strategy, which is managed futures. So, manage futures sounds very fancy and very strange. Realistically speaking, it is nothing more than trend following. So we talked about trends in our, one of our previous episodes about technical analysis, that's really what they're doing, they're investing in a trend, they don't care if the, the underlying investment is going up or down, they just want to see it going one way or another, flat or volatile markets, kill managed futures strategies. They also don't care what they invest in, as long as there is a futures market for that investment. They're happy to take advantage of the trend, whether it is up or down. So you know, futures on precious metals, commodities, like corn, soybeans, oil, timber, they're never actually buying the the asset itself. They're just investing in the futures contracts of those investments, and they are counting on the trend, whatever direction it's going, continuing.
Chris Holling:Isn't that what, what Eddie Murphy was bidding on in Trading Places about orange juice, and
Sean Cooper:I haven't seen that since for a long time, but I believe so.
Chris Holling:Okay, well, you should go watch that again.
Sean Cooper:Okay, I should, I should. Yeah, so we'll talk about futures more in a future episode. But that is basically what they're doing, they are buying into a trend, it doesn't matter what the underlying asset is, it doesn't matter which direction it's going. They just are counting on it continuing to go in that same direction. And you'd be amazed how well they do about getting that right now. Where managed futures suffer, again, is any type of flat market or volatile market that's just bouncing up and down, that those tend to be really hard on managed futures strategy, strategies. Additionally, when the market corrects, they tend to suffer briefly. So managed futures, always tend to miss the bottom of the market and the top of the market. So in a bull run, they'll miss the bottom 10% in a, as it reaches its peak and curves back around, they typically don't get out until it starts to curve back around. So they will have lost again, the top 10% or ish, it all depends on the strategy that they're employing. But they're their goal is to capture that middle 80% of the trend, and do it in a big way, because a lot of them will utilize leverage in their investment strategies. So the reason these strategies. fall under alternatives is, I mean, obviously, it's not your traditional investment. But the nice thing about it from a correlation standpoint is like I said, they don't care which direction the markets going. So you look at, again, 2008 managed futures strategies made depending on which strategy you were following, made anywhere from 20% to 150%.
Chris Holling:Geez,
Sean Cooper:yeah, they had some big gains in managed futures, in 2008. And, you know, obviously, that, that, that bottom in the shift to going going into 2009 hurt them, but they'd already made so much money didn't matter. And then when the market started to recover, and it started to trend upward again, they made good money again, so they can make money in both markets. It's just those those shifts in direction that tend to hurt them.
Chris Holling:Yeah, that makes sense. It's kind of hard to I mean, any of this is just hard to manage, predict. I don't know just just options, I guess, right?
Sean Cooper:Yep. And speaking of options, the next one I was going to discuss would be covered calls. So that isn't options are another derivative. calls are a type of option. In this case, I'm talking about covered calls specifically, which means you are already covered on the call as opposed to a naked call which is uncovered and we'll talk about that more in the future. But basically what that means As you already own a stock, so you own the underlying investment, and then you sell calls to other people. So you're selling other people the option to buy the stock that you own. This, you're still ultimately investing in a traditional asset class, but you're adding an alternative strategy on top of it. And what that does is it does limit some of your upside potential. But it also bolsters your rate of return both in bull and bear markets to a certain degree, because you're receiving a premium for all of those calls that you're selling. Your hope, ultimately, is that those calls just expire worthless, and you just get to keep the premium and keep holding on to your investment. But depending on how the call strategy is structured, typically speaking, even if the call does get exercised, you're probably selling the underlying asset at a profit. Plus, you took in the premium on top of it. So it helps mitigate downside risk and provide a more consistent return almost kind of like a dividend, but not as structured as a dividend. So it helps smooth again, it helps smooth out the ride. And that's why I put it more in that alternative to fixed income. So alternative strategies,
Chris Holling:right. alternative strategy within a traditional,
Sean Cooper:exactly. Yep, you got it.
Chris Holling:Gotcha.
Sean Cooper:And there are different versions of that you can that you can employ, but that that tends to be viewed as the safest methodology for for doing so because it is covered. And then the last alternative strategy that I was really going to delve into would be convertible arbitrage. And so again, this would be more traditional investments, but with a alternative strategy overlay. So there are types of bonds out there that you can buy that instead of being a traditional bond it is a convertible bond. And what that means is you can actually convert the bond into the stock of the underlying company, these bonds, convertible bonds, tend to pay lower dividends, then you're the company's normal share of bonds. And that's because they've given you that option of converting to stock, but that option is also giving you something of a benefit in that a, you're not completely tied to the performance of the underlying stock. You still have that bond, you still have that that fixed payment and that fixed asset value at the end provided the company doesn't go bankrupt. But you still have that flexibility of going Oh, yeah, the stocks doing really well. I'll convert and take my profits on the stock because the conversion rate is typically fixed.
Chris Holling:Okay, yeah.
Sean Cooper:Now with convertible arbitrage, they they throw in an additional twist, where they might, you know, short the they might buy the convertible bond, but then short the stock and they they take it's an arbitrage play, where they're taking profits off of one and using the other as a to offset kind of risk to a certain degree. It's It's a strange strategy that
Chris Holling:doesn't that just kind of wind up leveling out in the process?
Sean Cooper:Oftentimes, yes, it tends to be a very low rate of return play. Yeah, it's considered um, the only place they've really been able to classify is market neutral, which is questionable, but the nice part about it is it has very low correlation to your traditional investments. And by low, I don't mean really, like, way negative, it's just like, right around zero. So it has no correlation to traditional assets, either stocks or bonds. And it still provides a slight rate of return over the excuse me over the long term. And that rate of return does tend to be in line with bonds.
Chris Holling:So just sounds like a complicated way to not do a bond.
Sean Cooper:Kind of, yeah. But you're also taking some of the risk off the table
Chris Holling:Sure. Yeah. I guess it makes sense.
Sean Cooper:Yeah, that was the extent of what I wanted to cover. Like I said, there are other alternative assets or other alternative strategies, but this gives you a taste at least of some of what's out there. And why Why you might might want to consider them. And we briefly touched on why most people are not invested in them. But we can certainly discuss that more in the future. But it has to do with both awareness and large companies, larger investment companies that you might be investing with that just don't want to take on the the internal risk associated with it. associated with being sued, basically.
Chris Holling:Yeah. That That makes sense. Well, I mean, I think that's important, especially because you you personally get involved in it more commonly than than others. Do, I figure that's at least noteworthy to make sure that you're, you're taking time to learn more about it, maybe it's maybe it's time to have more than 10% involved in there.
Sean Cooper:Right.
Chris Holling:I think That's a good point. Okay. What else we got, do we? I mean, we got that we got
Sean Cooper:That's alternative investments in a in a nutshell,
Chris Holling:in a nutshell, in a pretty little nutshell. Cool. Okay. Well, I guess I guess we should magically wrap this up. Thank you, again, for joining us here on the truth about investing back to basics. Next time, we're, it's it says it says I'm being interviewed is, is what is listed on here.
Sean Cooper:Oh, are we talking about your real estate investment? Going to delve into real estate some more.
Chris Holling:alternative investments, talking about real estate investments from from a newbie from a novice side,
Sean Cooper:yeah.
Chris Holling:So it'll we'll we'll roll over from alternative investments and just keep rolling on with it. And I have no idea what this is going to look like. But hey, you know, I'm not the one interviewing me. So well, we'll find out, Sean. But yeah, otherwise,
Sean Cooper:I'll come up with some good questions we'll stump Chris.
Chris Holling:Yes, it'll be a five minute episode. But yes, thank you again for coming to join us and thank you for taking the time to want to learn how to better yourself. Here on the truth about investing back to basics podcast, my name is Chris Holling.
Sean Cooper:And I'm Sean Cooper,
Chris Holling:and we will catch you next time. podcast disclaimer. The disclaimer following this disclaimer, is the disclaimer that is required for this podcast to be up and running. And moving forward. This is going to be the same disclaimer that you will hear in each one of our episodes. We hope you enjoy it just as much as we enjoyed making it.
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Chris Holling:But there's there's only a I guess one more question that pairs along with that is Do you know what a pirate's favorite letter is?
Sean Cooper:RRRR
Chris Holling:Oh, you'd think it'd be RRRR but it's actuall the sea
Sean Cooper:Fair. Well played.
Chris Holling:Thank you. Okay, proceed. I got that out of my ystem.
Sean Cooper:That's good. That's good. We needed a dad joke, somewhere