Researching and choosing investments can seem daunting for those just starting their investing journey. Even seasoned investors can struggle with all of the options available these days. Stocks, bonds, exchange-traded funds (ETFs), mutual funds, commodities, real estate, crypto, and so many other asset classes can make understanding investments a challenge.
At Allio, we believe in financial wellness for all. And while you don’t need to be a financial expert to save and invest with Allio (our pros do the work for you) it’s always a good idea to have a solid understanding of the investments in your portfolio.
Stocks are perhaps the most common type of investment. Owning stock in a company means you have an equity stake in the firm’s assets and profits. Of course, by owning stock in some of the biggest companies in the world, your slice of the pie is quite small. Through time, though, your investment can grow to a large amount.
Also dubbed “equities” in the financial media, this type of investment is often highly “liquid” for the most popular and largest companies. They are bought and sold on exchanges across the globe. What’s more, you can trade stocks at virtually no cost these days. It used to be that brokers charged large commissions to execute a trade on your behalf. Through technology and competition, that’s no longer the case.
For background, companies issue shares to the public so they can raise cash to reinvest in their businesses. Early-stage firms seek to go public through an Initial Public Offering (IPO) whereby a select group of investors gets access to primary market shares. The stock then begins trading on the secondary market, like the New York Stock Exchange (NYSE). From then on, individual investors can buy and sell their stock as market-watchers can see the stock prices, an indication of a firm’s value, each trading day.
There are two forms of stock: common and preferred. Common shares are what you typically see run across the ticker page on an investment site or on financial TV. A shareholder is last on the pecking order should a business go bust, so owning common equity is considered a riskier venture for investors compared to being, say, a bondholder. With preferred stock, the investor does not have voting rights as a common stockholder does. They do, however, have a priority claim on dividends should the underlying company get liquidated or go bankrupt. But that's not to say that preferred stock is any better to own for the long run versus common shares.
With a little know-how under our belts, let’s take a look at how stocks tend to perform over the short term and through the decades. The whole goal of investing is to make money, right?
While it’s great to know the inner workings of various asset types, having an idea of what returns will be is often what people want to know. For stocks, you should expect volatility over short time horizons, say a few months to a few years, but over longer periods, returns tend to even out for a diversified stock portfolio.
For example, your chance of seeing a loss on a given day in the stock market is 46% using S&P 500 data going back to 1929. Stretch out the timeframe to 10 years, though, and there’s just a 6% chance you’ll be in the red, according to Bank of America. As for how much you should expect to earn, the long-term average is about 6.5% to 7% (after inflation), according to McKinsey. In the years ahead though, we believe that figure could be lower due to higher valuations today.
At Allio, you can build your net worth over time, brick by brick, with our low-cost, diversified portfolios. You can also invest in your values through our proprietary values-based investing baskets. Our platform even performs tax optimization automatically for you, helping to save you money on your journey toward financial independence.
While owning stocks is an ideal way to build your net worth over years and decades, if you have a near-term need for cash, then parking money in bonds might not be a bad play. Why’s that? It's because bonds generally have a fixed maturity date and promise to pay periodic “coupon” (or interest) payments until you get your principal amount back at the bond’s maturity date. Moreover, a bond is higher on the pecking order (called a firm’s capital structure) than common and even preferred equity.
A bond is a fixed-income security that is simply a loan made by a lender to investors. Like an I.O.U., bonds are issued by corporations big and small, and governments (federal and municipal), and they can be relatively safe or highly risky. Firms raise capital through bonds to fund projects and expansions while governments often finance public projects and pay their bills with debt.
It used to be that a bondholder would receive a certificate with perforated coupons that the investor would mail in to receive their periodic interest payment. Today, of course, it’s primarily electronic, but the covenants remain the same. A bond outlines when the loan is due and what the percentage of periodic payments owed to its holder will be.
Fixed-income assets, such as bonds, are highly dependent on the interest rate market. When rates are high, it is thought to be a good time to own bonds since you can earn a high yield relative to when market interest rates are low. Hence, when rates increase, old, lower-yielding bonds, drop in value since someone can buy new, higher-yielding bonds on the open market. When rates fall, bond prices rise. Thus, during years of rapid interest rate increases, the bond market can really suffer. The upshot is that new fixed-income investors benefit from being able to purchase bonds and earn a higher yield.
There are many flavors of fixed income. Corporate bonds are usually riskier than default-risk-free Treasuries. You can also invest in emerging market bonds which can be particularly volatile. Individuals in a high tax bracket can choose from a variety of municipals that offer tax advantages, too.
As for performance, expect less upside potential with bonds. But with less reward comes lower risk compared to stocks. Your net return on a portfolio of bonds is highly dependent on the starting yield. Data from NYU Stern show that from 1928 through 2021, the average annual return is about 4.8%. After inflation, that’s just 1.8%. While less than what you might get from a diversified portfolio of equities, it beats the paltry 0.3% inflation-adjusted long-run return on cash.
While stocks and bonds usually comprise most folks’ investable assets, there are so-called “alternative assets” that are easier than ever to own these days. In fact, Allio’s global macro portfolios include a combination of both traditional investments and alternatives.
Alternative asset classes are a great addition because they can potentially dampen a portfolio’s volatility while still producing sizable returns over the long term. The idea is that alternative assets can zig when the market zags. Another upshot is that alternatives can help weather inflationary storms. Allio’s team of hedge fund veterans study the past and look to the future so that your money is strategically aligned.
Let’s outline some of the alternative investments we include in client strategies.
Real estate is often a core holding in diversified investors’ portfolios. What’s appealing about real estate investments is that many companies who own land and operate buildings are required to pay out at least 90% of their taxable profits as dividends to their investors. These are known as equity Real Estate Investment Trusts (REITs). There are also REIT ETFs that feature a low annual expense ratio.
While you might first think of real estate investments as having a stake in firms operating rental units, some of the biggest real estate companies in today’s economy have operations in communications (like cell phone towers), health care (think hospitals), hotels, industrial parks, and offices. More broadly, real estate investments are usually broken out into residential and commercial. Equity REITs can also perform well when rent prices are climbing and inflation causes higher interest rates.
A slice of the international stock universe is Emerging Markets, or “EM.” This area, which comprises about 10% of the world equity market, is often more volatile and riskier than owning a basket of blue-chip, dividend-paying, U.S. corporations. The term “emerging” describes countries and regions that are between the developing and developed stages. Emerging areas generally exhibit rapid economic growth along with sharp downturns.
Investing in EM often carries with it heightened political uncertainty, currency risks, and bigger economic boom and bust cycles. The upside, though, is that investors are thought to be compensated for that bigger risk with a solid long-run return premium. For this reason, EM may offer investors greater potential for growth in the decades ahead.
Additionally, there are times when emerging market stocks and bonds can outperform the U.S. stock market thanks to global growth spurts and booms in countries such as China, India, and Taiwan. Another reason for including EM stocks in your stock basket is that the group boasts a valuation cheaper than that of the S&P 500. They also have a bigger dividend yield in many cases.
Commodities can be an opportunistic place to invest when times get shaky around the world. Geopolitical tensions, inflationary spirals, and high volatility in traditional asset classes often put commodities in high demand. Rising consumer prices, like what we saw in the 1970s and just recently, tend to be a boon to commodities and commodity funds. In years when stocks and bonds fall, commodities can be the lone asset class that rises in value.
Investing in commodities usually means having exposure to energy, metals, livestock, and agricultural products. While these areas don’t offer dividends or interest like real estate, stocks, and bonds, their prices are typically uncorrelated to traditional investments – that makes for a solid addition to investors’ portfolios. Unique supply and demand dynamics in niches like oil, natural gas, lumber, cotton, wheat, industrial metals, and so many more can help diversify your returns.
Investing in gold is easy these days. There are large and highly liquid gold ETFs we include in portfolios that closely track the performance of the “yellow metal.” Like investing in a broad commodity ETF, holding some gold can reduce overall portfolio volatility. During stressful periods and market turmoil, gold is often seen as a safe haven asset and a store of value. Its performance over centuries suggests that it can be a place of stability in an uncertain world.
Cryptocurrency has had an impressive performance track record over the last decade-plus, even with large drops along the way. What's advantageous from a portfolio perspective is that owning this alternative asset class can offer uncorrected returns at times to a traditional allocation to stocks and bonds.
The two major cryptocurrencies are Bitcoin (BTC) and Ether (ETH). There are also other big crypto assets like Cardano (ADA), Solana (SOL), and even stablecoins. As always, a prudent action is to ensure your portfolio is diversified through more than one token for your crypto exposure.
At Allio, we are optimistic about cryptocurrency’s future. The technology has the potential to build the infrastructure of tomorrow. But with any emerging technology and financial revolution, expect major swings along the way. Using ETFs to access crypto is a sound strategy to ensure diversification.
The Bottom Line
We believe in a macro investing strategy using both traditional investments and alternatives. Stocks and bonds are unquestionably a staple of a strong allocation, but adding other assets like real estate, emerging market equities, commodities, gold, and digital assets can help optimize your allocation.