Why Alternative Investments Should Be Included In Retirement Portfolios

Why Alternative Investments Should Be Included In Retirement Portfolios
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Ask most independent financial advisors what their clients’ number-one investment goal is and most often you’ll get the response “they don’t want to run out of money in retirement.”

These clients may get to pick when they want to retire, but they don’t get to pick where the S&P 500 is when that time comes, nor the price of bonds.  So, priority one for advisors should be protecting their clients’ nest eggs from market volatility so that their retirement doesn’t get derailed or pushed back.  And while many advisors think their clients may have a diversified strategy largely through traditional modern portfolio theory with a 60-40 allocation of publicly available stocks and bonds – new research shows that smart diversification includes having an allocation in alternative assets for truly reducing risk and attaining excess returns for accredited investors.

Studies show alternatives are an effective retirement plan option, especially in TDFs (Target Date Funds). This timely research should prompt advisors to reconsider traditional retirement planning. Broadening investment alternatives in a target-date fund structure enhances returns, according to new research by Georgetown University’s Public Policy Center for Retirement Initiatives, in conjunction with Willis Towers Watson.

Key findings of the research point to three important conclusions:

An enhanced retirement outcome.  Strategic use of alternative assets in a TDF structure, or a diversified TDF, demonstrates that including these asset classes can improve expected retirement income and mitigate loss in downside scenarios. As modeled for this analysis, a diversified TDF increases the amount of annual retirement income that can be generated by converting a participant’s DC balance into a stream of income at retirement by 17% or $9,200 for every $100,000 of pre-retirement annual wages in the expected case (50th percentile) or by 11% or $2,300 in annual retirement income in a worst-case or downside outcome scenario.

Risk mitigation. Having alternative assets in a defined contribution plan in retirement, according to the study, improves the probability of not running out of money over a 30-year retirement period and “provides higher expected returns and lower downside risk at the time of retirement.”

Wealth accumulation over the long term. While equities provide strong returns over the long term, the case for holding more than just stocks is that it can take them long periods to obtain their strong returns. In the meantime, sometimes over 10-year return periods, equities could hurt those in retirement during shorter holding periods.

When stocks return to the mean, that will have an impact on investors in the middle of building retirement nest eggs. To mitigate that volatility, alternatives can have a strong effect on wealth accumulation. Though the S&P 500 is up 13% percent this year, the index is down 1 percent from the peak set in January 2018 and down about 3 percent from the peak set in September 2018 (as of August 14, 2019). From peak to trough the S&P 500 drew down nearly 20 percent from September 2018 through Christmas Eve last year.  During the financial crisis of 2008-2009 it was even worse, with the trough drawdown more than 52 percent.

There is over $25 trillion held within U.S. retirement accounts, and less than 2% of those dollars are invested in alternatives. In order to make a significant difference in a portfolio, an accredited client approaching or in retirement should have at least 10 percent allocated to alternatives in retirement assets.  Advisors should consider alternatives in retirement assets with little correlation to the stock market, such as hedge funds, private equity, real estate and other untraditional, or alternative, investment vehicles. That, a growing number of financial advisors agree, will provide clients a better long-term return, with fewer scary periods of poor performance during inevitable market cycles.

Steven Brod is the Chief Executive Officer of Crystal Capital Partners. Crystal Capital Partners is a leading turn-key alternative investment platform, providing financial advisors with exposure to third-party institutional private equity and hedge funds for their clients’ portfolios. Crystal’s clients include independent advisors, regional banks, IBDs and multi-family offices. Crystal is a Registered Investment Advisor headquartered in Miami, Florida.


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