Stocks, bonds, and cash are your main fuel source. But other investments are available.
While it’s completely possible to build a strong investment portfolio without looking further than stocks, bonds, and cash—or the funds that invest in them—there’s a range of other investment opportunities that can help you achieve your financial goals.
Some choices, like real estate or collectibles, have the added advantage of giving you something tangible to enjoy while you’re investing.
Others, such as options, futures contracts, start-up companies, or companies that aren’t publicly traded, are higher-risk choices that you may not be ready to consider just yet—or that you may not yet qualify to get involved in.
THE REAL (ESTATE) DEAL
Whether you’re living in property you own or living off money you make from renting your property, real estate is an investment. And it’s often a good one. Real estate may increase in value, and may provide some valuable tax advantages, including being able to deduct your mortgage interest and property taxes on your federal and state income tax returns.
If you make a profit on the sale of your home, there’s another break. If you’ve lived there for at least two of the five years before you sell, you don’t have to pay any capital gains tax on up to $250,000 of your profit if you’re single, or up to $500,000 if you’re married and file a joint return.
Of course, there’s no guarantee you’ll make money in real estate. And you could have a harder time selling at a profit than with other types of investments. That’s because real estate is illiquid, which means it can take time to convert your investment to cash, especially if you try to sell during periods of high mortgage rates or limited demand. And you may have to settle for less than you paid if you need to sell at a certain time.
If you don’t want to lay out all the money necessary to invest in actual property, you can buy shares in publicly traded Real Estate Investment Trusts (REITs), which invest pools of money in a variety of real-estate ventures. Of course, REITs have risks as well, but they offer you potential gains with less time commitment than if you were buying property on your own.
A MATTER OF TASTE… FOR A PRICE
Collectibles include objects like fine art, antiques, stamps, coins, toys, fine wine, rare books or music, and basically any other possession that people consider valuable.
Focusing on collectibles can make investing a lot of fun, and you can make a good deal of money if you have an eye for what will be hot in the future.
But unlike publicly traded securities or mutual funds, for which there are organized and efficient markets, there’s no guarantee that anyone will want to buy what you have when you want—or need—to sell it. This uncertainty means there’s no way to anticipate the level of return this type of investing may provide.
Precious metals like gold, silver, platinum, and palladium can add enduring value to your portfolio, although their market prices vary drastically with supply and demand. If you’re just getting into investing, it can be risky to own metals directly by buying actual gold bars or certificates that represent ownership from banks or other institutions. Buying stock in mining companies—or better yet, shares in mutual funds that invest in these companies—can give you a little more liquidity and diversification.
ONE STEP REMOVED
A derivative is an investment, such as a futures contract, whose value depends on the value of an underlying investment, such as a commodity. (Commodities are the raw materials in consumer products, such as wheat or crude oil.)
Derivatives can be attractive because they allow you to use leverage to invest without laying out a lot of money. But derivative prices are volatile, which means you can lose money just as easily as you can make it— sometimes at lightning speed. And the dangerous side of leverage is that you can actually lose more than you invested, which isn’t the case with stocks, bonds, or mutual funds.
When you buy or sell a futures contract, you’re agreeing to buy or sell a specific amount of the underlying investment by the expiration date on that contract. But since there’s no guarantee that you’ll make money on the transaction, what most investors do is buy an offsetting contract as well—for example, one that requires them to sell if their original contract requires them to buy—hoping to make money on the changing value of the contracts.
When you buy an option, you pay a premium for the right to buy or sell a specific amount of the underlying investment at a predetermined price, known as the strike or exercise price, within a particular time frame. Unlike a futures contract, which you’re required to settle, you’re not obligated to do anything if you buy an option. You can just let it expire, so your only cost is the premium you paid for the right to buy. But an option can be an opportunity to profit if you’ve anticipated correctly how the underlying investment is going to change in value and if you buy or sell accordingly.
If you sell an option, you collect the premium, but you’re obligated to buy or sell the underlying investment at the strike price if the option buyer exercises the option. That could mean losing money, possibly much more than you made on the premium.
But investing in options isn’t right for everyone. At the very least you should download a copy of “The Characteristics & Risks of Standardized Options” from the website of The Options Clearing Corporation at www.theocc.com and read it. Click on the Publications tab.