ETFs Are Not The Answer In A Volatile Market—Diversification Is

There is a general assumption that Exchange Traded Funds (ETFs) can act as a hedge against market volatility. Maybe that is because some view them as a passive investment. As one 2015 study about passive investing that appeared on the Securities and Exchange Commission’s website illustrated, ETFs "are playing the leading role in the rise of passive investing.”

 The authors continue on to note that some have suggested that, because of their passivity, ETFs contribute to “portfolio diversification,” which is important for any investor, and especially those who are investing for retirement.This is true only in part, according to the authors of the study. They write that ETFs are an easy way to buy the index for individual investors. As a result, they attract a lot of demand and have seen tremendous growth over the past two decades. The fact that ETFs are inexpensive relative to buying the underlying stocks also attracts tremendous interest. Basically, the trading strategies that were too expensive without ETFs suddenly become more affordable, easy and popular, thanks to these instruments.

When I was recently interviewed on this subject, I suggested that weighting your portfolio with ETFs does not represent true diversification. More complete diversification -- what we call “21st-century diversification” -- includes alternative investment vehicles, such as direct investment in private small businesses, turnkey rental real estate and possibly even digital currencies. This is important because alternative investments are only thinly correlated to the stock and bond markets.

Overall, making alternative investments can be a very good strategy because they zag when the public markets zig. So, the next question becomes: How do I access these investments? With the rise of several dozen mechanisms available to allow investments with small dollar amounts into everything from commercial real estate to direct investments into small businesses via lending or purchasing equity, it has never been easier to make alternative investments.

An even better option is emerging: you can diversify your retirement savings portfolio by leveraging the power of the Self-Directed Solo 401(k) or Self-Directed IRA, a service that Rocket Dollar offers. These instruments are imbued with certain tax benefits, as well as the ability to make alternative investments. I expect that more and more companies will emerge in the future to help investors take advantage of those instruments. Companies now exist to allow investors to participate with as little as a $100 minimum investment to buy a small stake in a commercial office building, buy secondary market shares of high-value private companies and lend money to a local business in your community.

How much should you place in alternative investments? A truly diversified portfolio could contain up to 10-30% of alternative investments, such as real estate, to withstand market volatility.

For example, alternative investments make up nearly 75% percent of the overall portfolio of Yale University's vaunted endowment portfolio. This portfolio has maintained an average annual return of over 12% for the better part of two decades now.

I have been in the financial services industry since 2000 and saw mutual fund companies successfully lobby Congress to implement a qualified default investment alternative (QDIA), which allowed 401(k) plans to automatically invest regular individuals into target-date funds that most closely match their retirement age (i.e., 2040 fund for a 45-year-old today turning 65 on or near the year 2045).

However, the same industry has proactively invested institutional money (such as Yale's endowment and pension plans) and wealthy individuals' money in an allocation that has been anywhere from 25% to 60% percent invested into alternatives. For most of the last 40 years, there weren't platforms or investments that regular individuals could invest in as easily as mutual funds.

However, with legislation such Title III of the JOBS act, which allows companies to raise up to $1 million via crowdfunding, creating dozens upon dozens of platforms, there are plenty of ways an average investor can get access to alternative investments. Rocket Dollar was established with the idea of empowering individuals to use the government retirement arrangements for investments that mean something to them.

A Rocket Dollar account simplifies the process of creating the Self-Directed Solo 401(k) account and the Self-Directed IRA account. High net worth individuals and institutions alike have been making alternative investments as a hedge for decades. It’s time for individual investors to consider doing the same and embrace the concept of 21st-century diversification, whether they do so with taxable monies set aside for such purposes or potentially using their retirement funds. Alternative investing and diversification has never been made more affordable or easy than with Rocket Dollar. Learn more today.

Written by: Henry Yoshida, CEO of Rocket Dollar, Inc.

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