Investment Fundamentals

Investment Fundamentals – Understanding the Opportunities and Risks

Whether you are starting to think about investing or seeking to optimize your portfolio, it is essential to understand the opportunities and risks associated with different investment types. There are seemingly infinite nuances, anomalies, and operational maneuverings at play when navigating the global financial markets. For this reason, the value of professional advice cannot be overstated. Selecting the right advisor can make a significant difference in an investor’s approach to growing and protecting wealth. These professionals are there to help you build a diversified portfolio that suits your short- and long-term goals. They are there to decode and identify the opportunities and risks in every investment option. They are there to see the floods coming and the skies clearing.

That’s a lot of power to just hand over to even the most seasoned financial experts. Here, we outline the opportunities and risks associated with different investments to help inform the right discussions with your advisor that can lead to an optimal portfolio. From traditional investments, such as stocks and bonds, to different types of alternative investments, we embark on a comprehensive journey to guide you through the nuanced terrain of portfolio construction and optimization.

Stocks – Embracing Growth Potential and Volatility

Opportunities

• Potential for capital appreciation – Stocks generally perform best as long-term investments. Investing in a good company at a fair share price and holding on to it through market cycles, that’s the idea. That, and the statistical likelihood that after considerable time has passed, if the company has maintained or accrued more profitability, the investment should deliver significant value to a portfolio.
• Dividend income opportunities – Some stocks can also be considered solid sources of income, typically via dividends, i.e., cash paid to shareholders directly from the company. Consider public companies that return what’s left in cash to shareholders when the business generates more cash than necessary to improve and grow.

Risks

• Volatility and market risks – If a company slips, fails, or even just steps briefly into bad publicity, there is the risk of permanent losses for the company and its shareholders. In addition, all companies are subject to changes and unpredictability in the market, making short-term investors much more susceptible to losses.
• Susceptibility to economic conditions – All businesses are impacted by changes in national and global economic conditions that could affect the stock market in general, regardless of how well a few individual companies might be holding up.

Bonds – A Steadier Counterpart

Opportunities

• Regular income opportunities–Because bonds are fundamentally loans to a company or government, with set interest payments and a pre-set maturity date, as well as a face value the borrower repays, they are generally less volatile than stocks.
• Generally lower volatility compared to stocks – Bonds are not market-predicated like stocks. And even in a worst-case scenario such as, for example, a bankruptcy, bondholders have higher priority for repayment before shareholders.

Risks

• Limited potential for substantial growth – Generally, bonds underperform stocks as long-term investments because so much of a bond’s worth is pre-set (interest payments and maturity dates).
• Interest rate risk and inflation concerns – Bonds can lose value if bond issuers are unable to make interest payments or pay up at maturity. In addition, bond prices have an inverse relationship with interest rates. Inflation, which causes a rise in interest rates, decreases the value of existing bonds, making bonds yielding fixed interest rates not so desirable during times of high inflation.

Hedge Funds and Private Investments – Alternative Strategies for Portfolio Consideration

Opportunities

• Access to Differentiated Investment Opportunities: Hedge funds and private investments offer differentiated investment opportunities that are not available to the general public, such as investing in a startup company or a private real estate project. These opportunities are typically geared towards high-net-worth individuals and institutional investors due to their high minimum investment requirements and potential risks.
• Longer-term horizon focused on value creation: Hedge funds use various investment strategies to generate returns regardless of market conditions, such as long/short equity, event-driven investing, and global macro investing. They may be better positioned to take advantage of market inefficiencies than traditional investment vehicles. Private equity and private credit investments provide access to differentiated deal flow and investment opportunities, especially for early investors, as they involve investing in privately held companies that are not publicly traded.

Risks

• Concentration and counterparty risk: Hedge funds and private investments often have a narrow focus, which means that investors are exposed to high levels of concentration risk. These types of investments also often involve complex financial transactions with multiple counterparties. If one of these counterparties fails to meet its obligations, it can have a ripple effect throughout the entire investment. While they have the potential to generate higher returns, higher returns come with higher risk, and there is no guarantee of positive outcomes.
• Illiquidity: Hedge funds and private investments typically have long lock-up periods, which means that investors may not be able to access their money for many years. This can be problematic if investors need liquidity for unexpected expenses or other investments.

Real Estate – Tangible Investments with Long-Term Potential

Opportunities

• Diversification benefits – Investing in real estate can diversify portfolio assets, and factors like natural appreciation, gentrification, and the numerous way real estate investments can reduce taxable income are sound sources of income and wealth-building potential. Also, unlike stocks, real estate is not as directly correlated with the overall stock market or subject to its fluctuations.
• Potential for appreciation and rental income – Rental income can be a dynamic source of personal revenue when a property appreciates because of upgrades or neighborhood/region quality of life improvements.

Risks

• Illiquidity and high transaction costs – Real estate is intended to be a long-term investment and not one meant to be liquidated easily. The “buy and flip” trend that preceded the 2008 housing crisis is enough to illustrate that, even if correlation doesn’t mean causation. Maintenance, upgrades, transaction costs, insurance, and myriad other aspects of owning property can make just breaking even a hurdle for some investors.
• Market fluctuations – The value of real estate can be highly unpredictable and subject to significant fluctuations over time. Various factors, including changes in the economy, shifts in population demographics, and changes in government policies are just some of the factors that can all contribute to this variability.

Commodities – Riding the Waves of Global Demand

Opportunities

• Potential inflation hedge – Commodities are more likely to rise during times of high inflation when the dollar loses value , making this an investment type that may provide benefits when inflation has other investments sinking.
• Opportunities in booming industries – Agriculture, energy, metals, livestock, and technology are all major commodities. These are reliable industries because they are essential to our survival anywhere in the world. Investing in commodities can be done by purchasing physical assets, like gold bars or other precious metals, or using futures contracts or exchange-traded products. Opportunities will always abound in the commodities sector because they are less subject to—but not exempt from influence by—the trends that affect other investment vehicles.

Risks

• Volatility and commodity price fluctuations – There’s no way of predicting how the influence of natural events like weather, geopolitics, and the world’s economy will affect commodity investments so there’s a unique risk factor involved. We need look no further than the events of 2020 to see how vulnerable commodity investments can be in the context of so many other natural and interconnected global influences.
• Limited ownership rights and storage concerns – One can own as many bars of gold as they can afford, but storing and raising these presents an entirely new set of concerns and responsibilities. In addition, energy commodities like crude oil are never entirely under an investor’s sole proprietorship so decision-making (as well as accountability) is limited.

Specialty Assets – Unconventional Paths to Diversification

Opportunities

• Lower correlation with traditional assets – Material investments like fine art, vintage cars, watches, wine, and coin collections are subject to an entirely different and often niche set of rules and circumstances than more traditional assets.
• Potential for attractive returns – A smart first edition volume collection or stable of vintage automobiles could verge on the priceless. Buyers may be rare but also more willing to pay the extraordinary to own one-of-a-kind literary works or Corvettes.

Risks

• Complexity and specialized knowledge requirements – Niche asset classes require special knowledge from experts in their respective fields that can balance input from a trusted independent financial advisor. A gallerist or fine art advisory expert is going to have a very different interpretation of a painting’s worth and potential value than a financial advisor whose interest is in managing that potential buyer’s wealth. That means the investor would be wise to learn as much about the gallery item for sale and its overall asset class as possible before investing. Alternative investment seekers should seek an independent expert in that asset class who specializes in both, for example, fine art and financial advice.
• Liquidity constraints and regulatory considerations – Offloading vintage cars and packed wine cellars can be slow to find takers, to say nothing of the intensive legal operations involved. That’s why specialty assets are usually long-term investments that are often passed along through family generations. The decision to sell requires major input from asset class experts as well as independent financial advisors and, possibly, legal counsel.

Like everything in life, investing has its risks and rewards, its predictable elements, and its surprises. While this article is for introductory, educational purposes, a more nuanced, in-depth understanding—with the help of a Private Advisor—is highly recommended for anyone who is looking to make informed, thoughtful investment decisions, given the dynamic nature of the macroeconomic and market environment. Connect with your Private Advisor to harness the power of our open architecture investment platform to co-create the investment roadmap designed to achieve your goals now and for the future.