Investing Beyond Publicly-Traded Securities

Whenever you have money to invest, there will be people who want to give you advice about how you should be investing it. Some of those ideas might strike you as attractive, including Investing outside the public markets. This is a broad category and can refer to buying stock in a startup, making a loan or investing in real estate. 

If you decide to make an investment outside of the public sector, you might want to ask yourself the following questions: 

Why Are You Making This Investment?

You should always have a clear reason for choosing an investment, and a non-publicly traded investment is no different. If you’re making a private bridge loan, the primary goal might be to earn a higher short-term rate of interest than is otherwise available. The motivation for investing in rental real estate might be to earn a (hopefully) steady stream of income, while an equity investment in a startup could be based on speculative hope for a high return. Regardless of what the investment is, understand why you’re making it, particularly since these types of investments are typically much less liquid and much less transparent than publicly-traded securities. (For more, see: Real Estate Investing Guide.)

Why Is Your Capital Needed?

In the initial phase of considering an investment, you should start with a healthy dose of skepticism and this question is helpful. A more pointed way of asking this question is: “If this investment is so good, why aren’t other investors flocking to it?” There can certainly be valid answers to this question. For example, in the immediate aftermath of 2008/2009, banks loans for rental residential real estate investment were almost non existent regardless of how good a deal was. Nevertheless, understanding why others aren’t investing can help you identify potential pitfalls.

Do You Have Insight or Expertise?

Ideally, you’ll have sufficient expertise to evaluate the investment or work with someone who has the expertise. Without that due diligence, you’re just depending on luck. Years ago, a friend invested in a can’t miss rental property - the price was attractive, the tenants were great and cash flow was good. Unfortunately, he underestimated maintenance costs given the house’s age and the investment return was a good bit lower than anticipated. Someone with expertise might have been able to identify this issue beforehand.

What Is the Potential Downside?

For equity investments, the downside is a complete loss of your investment, but that’s not necessarily the case with a secured loan. In the latter instance, it is helpful to understand what the collateral is and what value you might be able to recover from the collateral if the loan goes bad. In either instance, make sure your financial goals won’t be jeopardized if the worst-case scenario is realized.

How Does This Fit in Your Plan and Portfolio?

Financial plans are built around assets that generate some combination of income and growth, while portfolios are designed with an optimal combination of risk and return. Where does the investment you are considering fit in? If it is income producing, does it decrease the need for other income producing investments and is taxation of the income a concern?

Non-publicly traded investments are often riskier, so will your overall portfolio still meet your risk/return requirements if the investment is made? Make sure you understand how the investment fits into the big picture.

Investing outside the public markets requires a higher level of due diligence. The questions above can help you decide if this is the right move for your portfolio and overall financial plan. (For more from this author, see: 2 Not So Obvious Investment Management Lessons.)