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July 1, 2021
Diversifying your investments in many different types of assets is usually a good idea, but not all investment opportunities are created equal. Each has its own set of costs, tax implications, risks, and return prospects. For example, investing in startup companies is a high risk/high return proposition. While startups have the potential to grow at an exponential rate, most actually go out of business. So, you should invest in them if you’re prepared to lose your entire investment. Conversely, the real estate market may go up and down, but real property always retains some value. However, you should not expect real estate investments to go up at the same rate as stocks. Finding the right mix of investments is what’s most important. The challenge is that what’s right for others may not be right for you. Here are several things to consider when deciding how much to invest in what types of assets.
This is perhaps the most important thing to remember when building an overall investment portfolio. For example, while you can afford to take more risk with money that you do not plan to touch for the next 20 years, you shouldn’t be too aggressive if you want to buy a home in the next year. If you’re not sure how risky an investment is, remember that risk is correlated with return. Any investment that has the ability to earn double-digit-plus returns, also has the ability to fall in price — and probably by quite a bit. There is no free lunch when it comes to investing.
If you own an expensive home, it may be unwise to own investment property, especially if it’s in the same neighborhood. Similarly, if you want to invest in startups, investing in an angel fund with stock in multiple companies may be better than investing in one or two individual startups.
Maybe this means investing your retirement funds all in stocks, while maintaining a more balanced stock and bond portfolio in your after-tax accounts. A “core and satellite” approach may also be appropriate. This strategy entails investing the bulk of your assets — your “core”— in a balanced portfolio of public equities and bonds while having various “satellites” of riskier, less predictable investments.
Take the time to understand the tax consequences of investing in something. Will you be able to control the timing of taxes? At what rate will the gains or income be taxed? Are there any opportunities to minimize or shelter the taxes? For example, you can offset rental income with rental expenses while investments in startups might be eligible for the qualified small business stock gain exclusion. Taxes can materially affect the attractiveness of an investment opportunity.
Like many alternative investments, real estate and private equity often have limited liquidity. If you invest via a fund, the cost structure may be quite high. To avoid costly management fees, many real estate investors look to manage investment properties themselves. But if there are significant property maintenance or tenant issues, this endeavor can actually be quite time-consuming. Before you make an investment, it’s important to weigh these issues. It may be well worth the time and money if the potential return is high enough, but each opportunity should be evaluated on its own merits.
The bottom line is that it’s wise to do your due diligence before deciding how to invest your portfolio in various types of assets. An advisor can help you evaluate new investment opportunities for potential red flags, track your investments through time, and ensure your overall portfolio is tailored to your individual goals and objectives.
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Aaron is a Partner based in the San Francisco office. He provides comprehensive investment and planning advice to individuals. While Aaron works with a wide...
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