By Brian Perry
The term "real assets" refers to a broad category of investment options that are characterized by the fact that they are tangible (as opposed to stocks, bonds, and CDs which are "paper" assets.) Real assets, also sometimes called hard assets, can play an important part in any investment portfolio - including those focused on safety and income. However, there are some important caveats and additional considerations that come with investing in real assets. This chapter will discuss several different categories of real assets and analyze their benefits and drawbacks when it comes to investing for safety and income.
Due to the sharp real estate correction that occurred between 2006 and 2009, many individuals are hesitant to invest in real estate. However, real estate has provided an attractive investment alternative for many years and will likely continue to do so in the future. When talking about real estate, we must differentiate between actually owning physical real estate and owning securities that represent an interest in real estate assets.
Physically owning real estate can provide an excellent store of value and a hedge against inflation. Rental properties (whether residential or commercial) can also provide relatively consistent cash flow for investors seeking income. However, there are several factors investors must consider when purchasing physical real estate. Physical real estate investment can be time-consuming and can be prone to difficulties that are not present in other types of investing (i.e. fixing a broken water heater or dealing with difficult tenants.) Furthermore, real estate often requires a substantial initial investment, which can make it difficult for smaller investors to build a diversified portfolio. Finally, real estate is less liquid than most other asset classes making it difficult for investors to raise cash if necessary.
An easier way of owning real estate is to purchase securities backed by real estate properties. These securities can be stocks (real estate investment trusts, or REITs) or bonds (mortgage-backed securities or commercial mortgage-backed securities.) When purchasing these securities, it is important to analyze the underlying real estate that backs them in order to determine how stable the cash flows are likely to be. Although owning real estate securities is easier in many ways than owning physical real estate, an investor does lose the benefit of owning a real asset. All told, investors with the willingness and ability to invest directly in real estate should probably do so; investors with smaller portfolios or those who are uninterested in the effort required for direct real estate purchases should consider securities backed by real estate. (For more on real estate investments, take a look at Investing in Real Estate and Add Some Real Estate To Your Portfolio.)
For thousands of years, investors have viewed gold as one of the best stores of value, and therefore one of the safest investments in the world. In times of crisis or market panic, investors often flock to the safety of gold, pushing its price higher. Furthermore, gold is traditionally considered a good inflation hedge and during times of inflation the price tends to rise. Despite these benefits, gold has not been an exceptional long-term investment and has suffered through lengthy periods of underperformance, which are generally followed by shorter periods of strong gains.
Nevertheless, gold may be an appropriate holding as part of a diversified portfolio focused on safety. However, it is important to remember that gold does not provide any income and is therefore not appropriate for investors interested in generating cash flow from their portfolios.
Investors have several options for purchasing gold. First, they can go out and buy physical gold in the form of bullion or gold coins. This approach has several disadvantages, including the need to store the precious metal and keep it safe. An easier approach is to purchase shares in an exchange traded fund (ETF) that tracks the price of gold. This provides exposure to the price of gold without the necessity of storing the underlying assets. The drawback is that the ETF will charge a management fee which will slightly reduce the investor's total return on gold. A third method of tracking the price of gold is to purchase futures or options on gold; while this is an appropriate method for some investors, those most interested in safety should probably seek other alternatives. Finally, an investor can purchase the shares of companies involved in the gold industry. This method provides less direct exposure to the price of gold and is probably less desirable for investors interested in owning "real assets." (See Does It Still Pay To Invest In Gold? to find out the merits of investing in gold.)
Collectibles such as silver, jewelry, art, or even stamps and comic books can all be considered real assets. Many of these assets may act as a store of value and provide safety to an investor's portfolio while holding the potential for capital gains. However, most of these markets are highly specialized and investors should have a clear understanding of what they're getting into.
Many of these collectibles are intended to be purchased as part of a hobby or for other intangible purposes. Therefore, individuals will face unique challenges when attempting to navigate these markets with the intention of making an investment. Some of these challenges include a lack of information, difficulty finding available inventory, a lack of reliable pricing data, high storage costs, and very large differences in the prices at which similar items can be bought or sold. Also, most of these assets do not generate any income. All of these factors contribute to make many collectibles inappropriate for the average investor.
If an individual is interested in collectibles as part of a hobby or for aesthetic reasons, and if the investment aspect is seen as a bonus, these assets may very well form a reasonable portion of a diversified portfolio. Likewise, if an individual has some unique advantage and presents an unusual ability to profit in these markets, they should certainly pursue that opportunity. However, the majority of investors should probably leave collectibles to those truly passionate about them and instead focus on more traditional asset classes. (Read Contemplating Collectible Investments to learn more.)
This chapter discussed real estate, gold and collectibles. Investing in these real assets poses unique challenges not faced in many other investment options. Investors should carefully consider these challenges before deciding whether to include real assets as part of a diversified investment portfolio. If, after carefully considering the challenges, investors do decide to purchase real assets, they will find that they often serve as an excellent store of value and as a hedge against inflation. As such, they could form a valuable component of a portfolio focused on safety of principal. However, gold and collectibles do not generate income, making them inappropriate for individuals interested in generating cash flow.
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