Add Alternatives?

ALTERNATIVE investments—including hedge funds, real estate partnerships, natural resources and venture capital funds—have long fascinated investors. Folks love the idea of owning sophisticated and often exclusive investments that not only have the potential to post gains when stocks are suffering, but also could deliver outsized long-run returns.

Indeed, in recent decades, there’s been much chatter about the so-called endowment model, which is closely associated with the late David Swensen, who oversaw Yale University’s endowment. Swensen pioneered a strategy of investing relatively little in U.S. stocks and bonds, and instead allocating substantial sums to alternative investments—and he did so with great success.

But while alternative investments have been a big winner for Yale, everyday investors should probably be leery. Why? There are three reasons.

First, many alternative investments involve high costs. That’s mostly because alternative investments are usually actively managed. In addition, it seems managers believe they can charge a premium price for such exotic fare.

Second, while past performance is always a shaky guide to future returns, this seems to be especially true for alternative investments. Hedge funds, commodities and other alternatives have attracted heaps of investor dollars in recent decades, only to post disappointing returns. That disappointment has extended to stock market downturns, when alternatives haven’t always delivered the portfolio protection that investors expected.

Finally, amid all the hoopla over alternative investments, experts often fail to mention that investors already have easy access to a low-cost investment that’s had a long history of faring well during rough stock markets. Want to lose less money when share prices next plunge? A low-cost short-term government bond fund may be all you need.

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