Robert Farrington is a paid influencer for Masterworks. All opinions and advice are his own.
It’s been a crazy December in the stock market - one of the worst since the Great Depression. The S&P 500 was down over 8% for the month of December, cementing a 2018 loss of 6.2% YTD.
And 2019 doesn’t look any better, with some analysts expecting a recession this year or next.
But the truth is, no financial expert can time the market, and nobody knows what’s going to happen next. All you can do is create an asset allocation in your portfolio that matches your risk tolerance.
That’s where alternatives come in. Most advanced-level investors should look to diversify beyond equities into alternatives. Alternatives usually include hard assets, like real estate and fine art.
Let’s dive in on how to get started investing in alternatives like fine art and why you should consider it, and where to do it.
If you want to skip my thoughts and see what I’m talking about, check out Masterworks here >>
Why You Should Have Alternatives In Your Portfolio
Many people don’t understand why it’s important to diversify your portfolio. The idea behind diversification isn’t to boost returns (in fact, it usually doesn't). Creating a proper asset allocation and diversifying your investments is designed to limit volatility and downside risk in your portfolio.
When you’re young, in full growth mode, and don’t have very much in assets, huge swings in volatility and value don’t impact you very much. For example, if you have $10,000 in your 401k, and it loses 10% - you lose $1,000. That’s painful. But it’s not going to be very impactful on your life.
Now, if you have $1,000,000, and you lose 10%, that’s $100,000. That number could be more impactful to you - especially based on where you are in your life.
Investing in alternatives in your portfolio can limit volatility and downside risk. The idea is that these assets (mostly physical assets like fine art) have an intrinsic value as a hard good, and they rarely lose value over the long run. They may not grow as much (although some do), but they have a different risk profile than stocks and bonds.
Examples Of Asset Allocation Risk Mitigation
Let’s look at some examples.
If you had an 85% stock, 15% bond portfolio, you might see some great growth, but huge swings.
Using historical data since 1926, a portfolio with 85% stocks has seen a return of 9.85% annualized. But… it’s worst 12 month return saw a -60.78% year… That could be detrimental based on where you are in life.
If you look at recent memory, in the 2008-2009 financial crisis, the S&P 500 dropped 56% and took around 1.5 years to recover. However, during that time, fine art only dropped 26% and recovered faster.
Now, if you shifted a bit, to say 75% stocks, 15% bonds, and 10% cash, you would see an annual return of 7.96%, but your worst year would have only been -40.64%.
Now, if you add some alternatives into the mix, say 65% stocks, 15% bonds, 10% cash, 10% alternatives, you might see annual returns around 6%, but a downside risk of only -17.7%.
This is all just a scenario, but it shows how adding in different asset classes can lower volatility and risk - which can help you achieve your long term returns.
How To Invest In Fine Art
The big drawback with investing in alternatives (whether real estate or fine art) has always been knowledge. Unless you are very knowledgeable about a subject, how can you invest properly.
That’s where Masterworks comes in.
Masterworks has a team of art experts that buy paintings and fine art, and then they sell shares in the painting to other investors. They attempt to buy paintings below their estimates of market value, and their goal is to hold them for a period of 5 to 10 years.
However, the paintings are always for sale in their collection if they are approached by a collector.
The goal is, at some point in the future, the painting sells, and all the investors are paid according to their fractional ownership in the painting.
The great thing is that the minimum to get started on Masterworks is just $1,000. That makes investing in fine art affordable to many investors. And with Masterwork’s knowledge, it has the potential to be win-win.
Check out Masterworks here and see what are is available to invest in >>
What Other Alternative Investments Are There?
Fine art isn’t the only alternative out there. It’s just one of the few that’s becoming a bit more accessible to everyone.
Another of the most popular alternatives is real estate. Until a few years ago, real estate had large investing costs - but several companies have adopted a similar approach to Masterworks when it comes to real estate investing.
Some of the other main alternatives include:
The goal of all of these investments is the same: to diversify out of equities into other investable assets to mitigate risk or boost returns (or both).
What Are The Downsides
All investments have some type of downside, and investing in alternatives like fine art is no exception.
The biggest downside (which we talked about earlier) is the knowledge required. All alternatives require some specialized knowledge, but investing on platforms like Masterworks lowers this barrier quite a bit by relying on the knowledge of experts.
The other big downside is transaction costs. Almost all alternative investments have high transaction costs - to buy, sell, and even maintain. Equities, on the other hand, have seen their transaction costs drop dramatically over the past several decades.
Just think of buying real estate. When you go to buy, there are realtor fees, escrow fees, and more. When you own it, you have maintenance and taxes. And when you go to sell, more fees (upwards of 6%).
To invest with Masterworks, you’ll face a 1% management fee, and you’ll give them 20% of the profits when you sell. Compared to other alternative investments, this is very much in-line.
And it’s important to remember how that plays out. Since 2000, fine art has outperformed the S&P by over 180%, but net of fees, you might be closer in line to the stock market - with one big caveat.
The risk profile of your investment is very different, and that can lower the volatility of your overall portfolio.
Investing in alternatives isn’t for everyone. But for the investor who is looking to diversity into alternatives, Masterworks is a very interesting investment opportunity.
Given that your investment is backed by a real piece of artwork, and the investment is certified by the SEC, it’s very safe. And even for younger investors looking for alternatives, this can make sense.
The real question you need to ask yourself is where you are at in your life, what does your “correct” asset allocation look like, and should you consider alternatives like fine art.
If so, then check out Masterworks and see how easy it can be.
Browse Masterworks’ offerings here >>
Robert Farrington is America’s Millennial Money Expert® and America’s Student Loan Debt Expert™, and the founder of The College Investor, a personal finance site dedicated to helping millennials escape student loan debt to start investing and building wealth for the future. You can learn more about him here.
He regularly writes about investing, student loan debt, and general personal finance topics geared towards anyone wanting to earn more, get out of debt, and start building wealth for the future.
He has been quoted in major publications including the New York Times, Washington Post, Fox, ABC, NBC, and more. He is also a regular contributor to Forbes.