Alternative investments include anything that isn’t a traditional Wall Street investment such as stocks, bonds, and cash. Alternative investments can be real estate, options, peer-to-peer lending, private lending, etc. There are many ways you can reduce your exposure to traditional Wall Street investments without reducing your return on invested capital. 

Why You Should Diversify Away from Traditional Wall Street Investments

You may be tempted to go all-in to an ever-increasing equities market but hold on. As the stock market goes higher and higher, people are lured into investing in potentially risky assets. It’s only natural. People see their friends making money in the market or hear about how the market continues to go higher and they don’t want to miss out. Be careful with this kind of thinking. Make sure you have some of your portfolio outside of Wall Street’s hands. Take a look at alternative investments to help you reduce your risk and achieve a greater return.

The more money you have in funds through vehicles like 401(k)s, IRAs, and regular brokerage accounts, the more money Wall Street makes. Salesmanship, not necessarily investment acumen, is what drives Wall Street. Fees, commissions, and IPO payouts are just just some of these ways financiers and insiders make money from your money.

Let’s look at the Snap, Inc. IPO as an example of how Wall Street uses retail investors to cash out. Snap started trading on the NYSE on March 2, 2017. The IPO was oversubscribed (a fancy Wall Street term for good demand) and was initially priced at $17 per share. You likely couldn’t get it at the “low” price of $17, however. You, as a retail investor, may have been able to pick it up at $24 per share, the price at which it opened the day.

Who got it at $17? All those insiders and brokerage firms who subscribed to the stock prior to the IPO. The $24 per share price represents what normal retail investors buying on the open market could buy-in. $24 per share in SNAP values the company at about $28.8 billion! Billion with a “B” for company that had revenues of $400 million and lost over $500 million in GAAP earnings in 2016. That means SNAP started trading at a valuation of 72x its previous year’s revenue.

Just some context here:

  • Twitter (TWTR) trades at 4.2x its annual revenue
  • Google (GOOGL) trades at 6.5x is annual revenue
  • Facebook (FB) trades at 14.7x its annual revenue

SNAP is trading at a valuation so high that nearly everyone who puts money in at these levels will lose money. SNAP would have to grow its user baser and revenues at unprecedented rates for the next 10 years without a hiccup to justify such a valuation.

So who’s making money?

1) Snap, Inc’s Insiders – The 2 young gents that founded SNAP are worth about $5 billion each depending on the price of the stock on any given day. This is the endgame for many entrepreneurs: an IPO. They take their ownership to Wall Street banks and tell them they want to sell to the public. Look for similar IPOs from Airbnb and Uber in the future.

2) Wall Street Banks – Morgan Stanley and Goldman Sachs made about $47 million in fees for underwriting the IPO. Other Wall Street firms made another $38 million in fees according the the SNAP Prospectus.

I would never invest in a company that trades at such sky-high valuations or invest in IPOs in general. There’s just too much risk for the expected return. Couple that with the fact that there’s a 150 day lock up period where those insiders are just itching to unload shares and it leaves me with a bad taste in my mouth. Why would I buy shares in a company that trades at a massive valuation, loses money hand over fist, and where the insiders can’t wait to sell out? Two words: Sales & Hype. You didn’t buy SNAP…you were sold SNAP.

Is It Possible for “The Little Guy” to Make Money in Stocks?

Now that I’ve been sufficiently negative on the stock market, many of you may be wondering if you should be in the stock market at all. To this I say, “of course.” But the “How” and “What” are the important things you need to ask yourself when putting money in the market.

1) How Do I Invest? – A lot of people don’t know where to get started so they find the first person who mentions anything about investing. This person could be a broker, insurance salesman, CFP, or a fortune teller. Depending on who you ask will determine the approach you’re likely to take. If you go to a broker, they’re likely to put you in something that makes their firm (and them) money in commissions. The vehicle you choose is important.

2) In What Do I Invest? – Again, the answers vary depending on how the financial advisor is compensated. For example, a broker may put you in mutual funds. They’ll happily take the money you have sitting in savings, put it in their stewardship and invest in mutual funds. Brokers will call being diversified being in five different mutual funds. I disagree. The asset categories you choose to invest in can make all the difference in retirement.

Once you get past the “how” and the “what” (the “vehicle” and the “assets”, respectively), you need to work on your proper allocation. I’ve established the Triad Portfolio as an allocation model. I believe that everyone, not just those preparing for retirement, should have their money in three different portfolio categories:

  1. Risk-free Assets
  2. Core Assets
  3. Alternatives Assets

1) Risk-free Assets – This portfolio category is your dry powder that generates around the rate of a 2-year T-note. I like Treasuries for this category among other things. The goal with this category is simply to conserve capital and keep up with inflation. We’re not as concerned with the return on our money here as much as the return of our money. As valuations get higher and higher and the bull market gets older, I like a higher weighting to risk-free assets.

Some further thoughts on risk-free assets – Even though the market may continue to go higher and it would be beneficial for an investor to hold onto equities a little longer, there comes a point where valuations may be too high to warrant the risk of being in equities. The market will have to go up without me…or at least with reduced exposure. Using SNAP as an example – yes, the stock could go up to $30 per share but it will go there with someone else owning it.

2) Core Assets – This portfolio category contains two asset classes: stocks and bonds. Of those two asset classes, there may be many asset class segments. Here’s a rundown of some asset class segments:

  • Large-Cap Value
  • Large-Cap Growth
  • Small-Cap Value
  • Emerging Markets
  • Developed International
  • Short-Term Bonds
  • Long-Term Bonds

As the name implies, the Core Assets portfolio segment makes up the majority of your holdings in most cases. Your money will be allocated 40 – 80% to this category depending on your risk budget. Yes, this is mostly Wall Street assets. They’re not all that bad. You just have to know what to look for and how to reduce your overall risk.

I recommend the use of ETFs and index funds for most people in the Core Assets portfolio segment. ETFs and index funds aren’t as expensive as other options and you can take a more passive approach with them. I personally invest most of my Core Assets portfolio segment in individual stocks like Johnson & Johnson, ExxonMobil, Cisco, P&G, Target, etc. While the costs of owning individual shares is very low (only a small commission), it takes a lot of time and is probably not the right way to go for 95% of investors.

You can make a lot of money investing in the right kind of asset class segments. Problem is no one will ever call you up and try to sell you a low cost ETF. That’s exactly what you should buy them. The next time a broker tells you that you should invest in a mutual fund, ask him what the advantages are of being in a mutual fund over an ETF. And then sit back and get ready to laugh.

3) Alternative Assets – This category is slowing becoming my favorite category because of two main reasons: 1 – The stock market just keeps going up and up and it’s not as attractive as it used to be and 2 – There have been some real advancements in the different types of alternative investments, some of which I think are going to be the investing wave of the future.

The oldest, most time-tested alternative asset is real estate. This comes in many forms and the one with the most potential is likely to be owning real estate rental units. There are about 32 separate tax advantages like: phantom income from depreciation, 1031 exchanges, deducting Schedule C expenses, and the list goes on and on. You control the property. Wall Street isn’t taking their cut. The advantages of owning the right kind of real estate are abundant.

There are also disadvantages and barriers to entry. The main disadvantage I see is lack of diversification if you have limited funds to start with. Say you have a $100,000 total portfolio and you make an investment in a rental property that takes 35% of your portfolio. This one property represents a very high proportion of your entire portfolio. If something goes wrong, you may not be able to progress with your goals as you thought. You could be stuck earning inferior returns for a decade.

Own Real Estate More Efficiently

A couple of years ago, Warren Buffett said if there was an efficient way to buy a bunch of single-family homes, he’d invest heavily. He said that buying a single family home at such low interest rates will pay off big in the future. Everyone needs a roof over their head. Real estate is not likely to be displaced by technology anytime soon. Buffett never made direct investments in real estate because he couldn’t figure out how to do it efficiently.

A great new way to invest in real estate is through crowdfunded platforms. Crowdfunded real estate investing has taken off recently. There are companies you can invest through that allow you to start with just a $1,000 investment. Crowdfunded investing allows you to take part in a real estate investment without the huge capital commitment that comes with buying a rental property.

Here’s how crowdfunded real estate works. The platform finds companies and people who need capital to transact real estate deals.. You as an investor have the opportunity to review the various investments and choose how much you’d like to invest. You invest with other people (hence the term crowdfunded) to fund the deal. Then you get paid as either an equity or debt owner

You can invest in many different property types as a lender or equity investor depending on which platform you choose:

  • Single-family homes
  • Multi-family homes / Apartment complexes
  • Commercial Retail
  • Other Commercial

Not Thrilled with Crowdfunded Real Estate?

There are other options for alternative investments as well. I’ve been using covered call options in order to generate income for years. The key to making money in options is to just start. You’ll learn the most by simply trading in a virtual account to start before progressing to real money. It’s one of the safest strategies I use to generate massive returns. 

Here are a few other alternative investments so that you don’t have to put all of your money with Wall Street:

  • Peer-to-peer Lending (Lending Club, etc.)
  • Options (puts, calls, spreads, etc.)
  • Private Lending (lending money to get local private deals funded)
  • Private Equity Placement (think Uber circa 2011)
  • Venture Debt Investing

I’d like to know what your thoughts are. What alternative investments are you looking at buying? What percentages to you have invested in each portfolio category?