How to Diversify Your Portfolio with Alternative Investments (2024)

“Don’t put all your eggs in one basket” is a proverb that warns against investing all of your resources in a single source. If something were to happen to that basket, you’d lose all of your eggs. To mitigate that risk, it’s wise to spread out your assets. When applied to investing, this proverb directly speaks to the value of portfolio diversification.

Diversificationis an investment technique that aims to increase returns and decrease overall risk by allocating capital across investment types and industries. Whether you’re an aspiring portfolio manager or an investor curious about how your portfolio is constructed, it’s crucial to understand diversification’s value in the investment world.

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Why Build a Diversified Portfolio?

Portfolio diversification is based on the concept of complementarity, which describes the degree to which two or more assets move in opposite directions in specific environments or scenarios.

By selecting complementary investments, you can decrease a portfolio’s risk profile, regardless of the risk profiles of the investments it comprises. For example, imagine you’re a portfolio manager and choose to invest in two stocks: Investment A and Investment B. Investment A is in a package delivery company, and Investment B is in a videoconferencing platform company. Even if both investments are highly risky, the fact that they’re not in closely related industries decreases the portfolio’s overall risk.

For instance, if there were a gas shortage and the company couldn’t deliver packages, Investment A’s stock price might drop. Yet, Investment B’s stock price could increase, as videoconferencing wouldn’t be negatively impacted by a gas shortage. The gas shortage might even cause some people to work from home and purchase the videoconferencing platform, which could result in Investment B’s performance being negatively correlated with Investment A. You’re effectively putting your “eggs” (capital) in separate “baskets” (investments) to spread out risk.

Related: What Is Sustainable Investing?

3 Strategies for Portfolio Diversification

There are three primary strategies for portfolio diversification, and a wise portfolio manager considers all three.

1. Individual Asset Diversification

The first strategy is to invest in an array of assets within an asset class. This can be as simple as buying the market index—the S&P 500 or the Russell 2000—to ensure a variety of high- and low-risk stocks across industries are equally represented in your portfolio. It can also mean consciously investing in industries that seem complementary to one another.

2. International Market Diversification

The second strategy is to look abroad. If your country’s market were to perform poorly, it’s useful to have some investments in international markets to mitigate risk and balance your portfolio. Keep in mind that other countries may have different rules, regulations, and processes for investing than your country does.

3. Asset Class Diversification

The third strategy is to diversify by investing across asset classes. These can include traditional investments—such as stocks, bonds, and cash—which operate in the public market, and alternative investments, which primarily operate in the private market and are largely unregulated.

Alternative investments can be a beneficial addition to portfolios due to their high level of complementarity with traditional investments. Here’s a closer look at what alternative investments are and how to use them to diversify portfolios.

What Are Alternative Investments?

Alternative investments are any investment besides stocks, bonds, and cash. Alternatives are relatively illiquid—meaning they can’t be easily converted into cash—and unregulated by the United States Securities and Exchange Commission (SEC).

Some of the most common types of alternative investments include:

  • Hedge funds, which pool the capital of many investors and invest it across various securities with the intention of managing risk to outperform the market’s rate of return.
  • Private equity, which is the investment of capital in private companies and encompasses venture capital, growth equity, and buyouts.
  • Real estate, which is the investment of capital in residential, commercial, or retail properties, either individually or through a real estate venture fund or investment trust.
  • Debt investing, in which capital is invested in the debt of a private company and can be distressedor private.
  • Commodities, in which capital is invested in natural resources, such as oil, agricultural products, or timber.
  • Collectibles, in which items such as rare wines, cars, and baseball cards are purchased with the intention of selling them when their value appreciates.
  • Structured products, which involve fixed-income markets and derivatives.

Alternative investments are a wise addition to portfolios because they tend to have a low correlation with traditional assets. This means that if the stock market is doing poorly, some of your alternative investments could perform well. Because these investments are separate from the public market, they present a great opportunity to diversify your portfolio.

Related: The Future of the Alternative Investments Industry

Factors to Consider for Diversified Portfolios

The alternative investment asset class contains a variety of asset types, each with unique characteristics. How do you know which are the best fit for your portfolio? Several factors can help you decide. Compare each alternative type to the traditional investment types in your portfolio to ensure diversification.

Time Horizon & Liquidity

Time horizon is the amount of time an investor can expect to hold a specific investment. Time horizons vary greatly, ranging from a few hours to a few decades. Liquidity is tied to time horizon; if an investment has a long time horizon, it’s considered illiquid until it reaches maturity.

Traditional investments (stocks, bonds, and cash) have no set time horizon and are fully liquid. Investors can cash in their investments whenever they decide to.

Alternative investments are relatively illiquid and have much longer time horizons. For some alternatives, time horizons are set at the signing of a contract; for instance, when someone becomes a limited partner at a private equity firm. Others are long simply because they’re difficult to sell or require time to accrue value. Here are a few examples:

  • Hedge funds: Because hedge funds invest across various asset classes, their time horizons can be extremely short (a few seconds) to moderately long (a few years).
  • Private equity: Private equity’s time horizons are typically around 10 years.
  • Real estate: Institutional investors hold real estate investments for nearly eight years on average. Individual real estate investors aren’t tied to a specific time horizon, but it can be difficult to move a real estate asset quickly, depending on how the market is performing.
  • Commodities and Collectibles: Commodities and collectibles have long, flexible time horizons, as they both require time to accrue value. You need to watch the trends in your asset’s specific market to know when it’s best to sell.

Building a portfolio that includes a variety of time horizons and liquidity provides both flexibility and security to its investors.

Markets & Industries

To diversify your portfolio, select investments from various industries and markets. When investing in private equity or debt investments, explore industry trends for the private companies you’re considering and select companies in industries with a high level of complementarity. When considering real estate investments, spread out your capital between several types of real estate or geographic locations.

Risks & Potential Threats

Spreading out risk is one of the key goals of diversification, and alternative investments provide varying levels of risk to consider. Returning to the concept of time horizons, investment options with longer time horizons are typically less risky because the market has time to correct itself should a downturn occur. If, however, your investment is a physical asset—such as a building, natural resource, or collectible—a longer time horizon means more time for the asset to be damaged, stolen, or lost, which adds additional risk.

Consider the types and levels of risk already present in your portfolio and choose investments that complement them.

Using Alternative Investments to Diversify Portfolios

Alternative investments are key to a strong, diversified portfolio. Understanding the time horizons, liquidity, industry and market trends, and risk level of each type can help you select alternatives that mitigate your portfolio’s overall risk and increase returns.

Gaining a deeper understanding of each alternative investment type can serve you well as an aspiring portfolio manager. Consider taking an online course like Alternative Investments to build your knowledge base and sharpen your intuition for which investments are the best fit for a well-rounded, diversified portfolio.

Are you interested in learning how to build strong investment portfolios? Explore our five-week online course Alternative Investments and other finance and accounting courses.

As an experienced financial expert with a background in investment management and portfolio diversification, I can confidently discuss the concepts presented in the article you provided. Let's break down each concept mentioned:

  1. Portfolio Diversification: This is the practice of spreading investments across different assets or asset classes to reduce risk. It involves selecting a mix of investments that are not highly correlated with each other, so that if one investment performs poorly, others may perform well, thereby balancing out overall portfolio returns.

  2. Complementarity: This refers to the degree to which two or more assets move in opposite directions in specific environments or scenarios. In the context of portfolio diversification, selecting complementary investments helps decrease the overall risk of the portfolio.

  3. Individual Asset Diversification: This strategy involves investing in a variety of assets within the same asset class. For example, investing in a mix of stocks across different industries or sectors.

  4. International Market Diversification: This strategy involves investing in assets outside of one's home country to spread risk and potentially benefit from different market conditions and economic cycles.

  5. Asset Class Diversification: This strategy involves investing across different asset classes, such as stocks, bonds, cash, and alternative investments, to further spread risk and potentially enhance returns.

  6. Alternative Investments: These are investments beyond traditional assets like stocks, bonds, and cash. Examples include hedge funds, private equity, real estate, commodities, collectibles, and structured products. Alternative investments often have low correlation with traditional assets, making them valuable for portfolio diversification.

  7. Time Horizon & Liquidity: Time horizon refers to the length of time an investor expects to hold an investment, while liquidity refers to how easily an investment can be converted into cash. Alternative investments typically have longer time horizons and lower liquidity compared to traditional investments.

  8. Markets & Industries: Diversifying across different industries and markets helps reduce concentration risk. Investing in industries with high complementarity can further enhance portfolio diversification.

  9. Risks & Potential Threats: Diversification aims to spread out risk, considering factors such as time horizons, industry trends, and levels of risk already present in the portfolio. Alternative investments offer varying risk levels and can help mitigate overall portfolio risk.

  10. Building a Strong Portfolio: Understanding the characteristics of different investment types and considering factors like time horizon, liquidity, industry trends, and risk levels can help build a strong, diversified portfolio that aims to increase returns while reducing risk.

By applying these concepts effectively, investors can construct well-diversified portfolios that are better positioned to weather various market conditions and achieve their financial goals.

How to Diversify Your Portfolio with Alternative Investments (2024)


How to Diversify Your Portfolio with Alternative Investments? ›

Investors may diversify by blending different types of investments—like stocks, bonds, cash. They can also break these categories down further by factors such as industry, company size, creditworthiness, geography, investing strategy, bond issuer, and style.

How can you diversify your investment portfolio? ›

Investors may diversify by blending different types of investments—like stocks, bonds, cash. They can also break these categories down further by factors such as industry, company size, creditworthiness, geography, investing strategy, bond issuer, and style.

What is the role of alternative investments in a diversified investment portfolio? ›

By incorporating alternative investments into a portfolio, advisors can introduce a non-traditional asset class that has a low or even negative correlation with traditional assets. This low correlation helps to reduce overall portfolio volatility and potentially enhances risk-adjusted returns.

Which of the following is the best way to diversify your investment portfolio? ›

To achieve a diversified portfolio, look for asset classes with low or negative correlations so that if one moves down, the other tends to counteract it. ETFs and mutual funds are easy ways to select asset classes that will diversify your portfolio, but you must be aware of hidden costs and trading commissions.

What does it mean to diversify your portfolio group of answer choices? ›

Diversification is the practice of spreading your investments around so that your exposure to any one type of asset is limited. This practice is designed to help reduce the volatility of your portfolio over time.

Why do you diversify your portfolio? ›

Portfolio diversification involves investing in many different securities and types of assets so that your overall return doesn't depend too much on any single investment. Financial experts often recommend a diversified portfolio because it reduces risk without sacrificing much in the way of returns.

What is an example of diversification in investment? ›

Diversification is most often done by investing in different asset classes such as stocks, bonds, real estate, or cryptocurrency. Diversification can also be achieved by purchasing investments in different countries, industries, sizes of companies, or term lengths for income-generating investments.

How to do alternative investments? ›

Investors can access alternative invests in three ways:
  1. Fund investment (such as a in a PE fund)
  2. Direct investment into a company or project (such as infrastructure or real estate)
  3. Co-investment into a portfolio company of a fund.

What is the alternative investment strategy? ›

Alternatives invest in private markets and apply non-traditional strategies to public markets. Diversifying into alternatives may increase income and return potential while reducing risks. We offer insights and solutions for building stronger portfolios with alternative investments.

How much of a portfolio should be in alternative investments? ›

2. Right-size your alternative investment allocation. The next critical question for those who already are invested in alternatives: How much capital should I put, in total, to work in the private markets? The typical range we've seen among J.P. Morgan private bank clients is 15% to 30% of their overall portfolio.

What is a danger of over diversification? ›

The biggest risk of over-diversification is that it reduces a portfolio's returns without meaningfully reducing its risk. Each new investment added to a portfolio lowers its overall risk profile. Simultaneously, these incremental additions also reduce the portfolio's expected return.

Which stock will double in 3 years? ›

Stock Doubling every 3 years
S.No.NameCMP Rs.
1.Guj. Themis Bio.385.80
2.Refex Industries155.75
3.Tanla Platforms932.50
4.M K Exim India78.55
10 more rows

What is the rule of thumb for portfolio diversification? ›

First, set aside enough money in cash and income investments to handle emergencies and near-term goals. Next, use the following rule of thumb: Subtract your age from 100 and put the resulting percentage in stocks; the rest in bonds. In other words, if you're 20 years old, put 80% of your assets in stocks; 20% in bonds.

What is the diversification strategy? ›

A diversification strategy is a technique you can use to expand a business. This strategy helps encourage company growth by adding new products and services to the company's offerings. With these new offerings, the company can pursue business opportunities outside of its regular practices and markets.

What is diversification answer key? ›

Diversification is an investment strategy aimed at managing risk by spreading your money across a variety of investments such as stocks, bonds, real estate, and cash alternatives; but diversification does not guarantee a profit or protect against loss.

How does portfolio diversification work? ›

Diversification is the spreading of your investments both among and within different asset classes. And rebalancing means making regular adjustments to ensure you're still hitting your target allocation over time.

What is one easy way to diversify your investment portfolio is to buy? ›

If you're not super rich, diversification while buying individual shares can be costly because you might have to pay trading fees each time you buy a different stock. The most cost-effective way for investors of modest means—and that means people who have less than $250,000 to play with—is to buy mutual funds.

How should I divide my investments? ›

There is a simple explanation based on your liquidity needs. Accordingly, your portfolio should be divided between liquid funds and debt funds. Within debt funds how much should be in duration above 5 years and duration below 5 years. That will depend on your outlook on interest rates.

How do I make a good investment portfolio? ›

How to build a financial portfolio
  1. Establish the different types of portfolio investments. ...
  2. Put your money into different funds. ...
  3. Diversify across the same asset classes. ...
  4. Diversify across different asset classes. ...
  5. Determine your asset split based on your age. ...
  6. Continue to tweak your portfolio.

What is a good portfolio mix? ›

Many financial advisors recommend a 60/40 asset allocation between stocks and fixed income to take advantage of growth while keeping up your defenses.


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