The World of Alternative Investments

Conventional investments are always in the spotlight, but what about the alternative ones? How are investments in art, real estate, and other assets helpful in building your wealth? Danielle Labotka, Ph.D., Behavioral scientist for Morningstar joins Cassidy Clement, IBKR’s Senior Manager of SEO and Content to discuss.

Corresponding Morningstar Studies: 

https://www.morningstar.com/personal-finance/crypto-reits-private-equity-long-term-investments-or-short-term-trends

https://www.morningstar.com/financial-advice/how-talk-your-client-about-alternative-investments

Summary – Cents of Security Podcasts Ep. 43

The following is a summary of a live audio recording and may contain errors in spelling or grammar. Although IBKR has edited for clarity no material changes have been made.

Cassidy Clement 

Welcome back to the Cents of Security podcast. I’m Cassidy Clement, Senior Manager of SEO and Content at Interactive Brokers. Today, I’m your host for our podcast. Our guest is Danielle Labotka, PhD, and Behavioral Scientist for Morningstar.  

Her recent research examined how everyday investors think about alternative investments. Conventional investments are always in the spotlight. But what about the alternative ones? How are investments in art, real estate and other assets helpful in building your wealth? Well, we’re going to explore the topic today and in a discussion on alternative investments, look into some of Danielle’s research. So welcome to the program, Danielle. 

Danielle Labotka 

Thank you for having me. 

Cassidy Clement 

Of course. So since this is your first episode with us today, what is your background in the industry and what exactly does a behavioral scientist do? 

Danielle Labotka 

Yeah! Great. So my response here may be a little unorthodox compared to some of the other guests you’ve had, but bear with me. I promise I’ll get around to the point. 

So prior to entering the industry, I got my PhD in psychology from the University of Michigan and was a Postdoc there afterwards. And as I started to think about what I wanted to do with my research skills, I started to realize that I really wanted to do research that could be used kind of by anybody to improve their lives.  

And so I started to think about getting involved with behavioral finance. Now, behavioral finance is basically the study of how we interact with our money. I thought this was pretty great for what I wanted to do because after all, we all have to make decisions about money, even if my decision for the day is, I don’t want to think about it. Please make it go away.  

And I was fortunate enough to find a group at Morningstar. The Behavioral Insights group that does work doing just that. And so I’ve been a behavioral scientist in that position since 2022. But as you alluded to, a behavioral scientist is not really a clear thing for a lot of people. So like I said, we all have to make financial decisions, but unfortunately, we as humans don’t tend to be very good at it as just kind of a rule. I’m sorry, I wish it were different. Our brains are really these impressive, efficient organs that are really great at helping us make fast decisions on little data, and this has served humans well, not just in terms of our ancestors, but also like us, today.  

Think about how you would have to live your life if you had to really think about every single piece of information and decision you wanted to make. You basically would never get the day started. So this fast thinking is really important to us, but it really can get us into trouble when it comes to money. So as a behavioral scientist, I conduct studies on how everyday people think about finances from their financial goals to recessions to alternative investments. And from my research I glean insights that can be applied by individuals to help their financial decision making. 

Cassidy Clement 

That’s really interesting, actually. Behavioral finance, back when I was in business school, that always was kind of one of the elusive topics that you kind of touch on a little bit in early business school, in 101. 

But you never really delve. I think a lot of people like you had mentioned maybe in Masters degrees or PhD programs look a little bit more deeply because there’s so many facets that you have to understand, both from the psychological perspective and the financial area.  

So to tie this back to your research and the topic today. So alternative investments, that area, you were looking at how everyday investors, more of the average Joe, if you will, of investors, are viewing or thinking about alternative investments.  

So to start down that path, the most basic question, what exactly is an alternative investment and how did you focus on that in the study you did? 

Danielle Labotka 

Yeah. So very basically, an alternative investment is this broad term that encompasses any asset that isn’t stocks, bonds or cash, right? So that means that there are things as different as cryptocurrency and your grandmother’s antiques that both count as alternative investments.  

And so people are often looking at alternative investments because they want to diversify their portfolio. Or because there are some high returns that may be associated with them or other things. But people may want to be careful with alternative investments because there can be a lot of fees associated with them that makes them pretty costly investments. 

There also tends to be less transparency and liquidity. There’s also fewer regulations and there tends to be more risk so there’s a whole lot of different types of alternative investments out there, but those are kind of some of the general things that kind of run throughout those different types of investments.  

And in this study, we actually looked at 9 different alternative investments in total and I’m going to spare you the full list because some of them are quite technical and they’re not really worth going into at this point in time.  

But some of the big alternative investments that we looked at were cryptocurrency, which is just a digital currency that uses blockchain technology. Commodities, which are basic goods that are typically traded in large volumes like metals or livestock. Private equity, which involves buying ownership in companies that usually involves overhauling them and then selling them. And real estate investment trusts, which are more commonly known by their abbreviation, REITS, which are companies that operate income generating real estate. 

Cassidy Clement 

Well, with all of those, I just want to give our own show 2 shout outs. So you had mentioned Grandma’s antiques and REITS. So we actually did have a podcast recently recorded on real estate. And we also have a podcast on inheritance of how more people are, we’ll say most people are familiar with finding themselves owners of some of these antiques or art or anything along that line and they maybe didn’t expect to be in the alternative investment space, but now they have this old piece of artwork that they’re like, oh wait, this is worth some money. So now I have to learn about this market. That may be a little bit more aligned with some of the ways that some people are introduced to this. The other ways, the art or antiquity side may be for younger listeners or millennial listeners. The Beanie baby craze, maybe Pokémon, things of that nature where you start to have the collectibles enter the space.  

So what did you find in the study to be more of the popular alternative investments? Because there are some that you said you didn’t even have to mention because they were highly technical, but there may be ones that are so popular that people may not realize. Like I had mentioned the collectibles area. 

Danielle Labotka 

Yeah, right. Yeah. So the result here is probably not going to be too surprising to your listeners, which is that the most popular alt in our study was cryptocurrency. About half of the people we surveyed actually owned crypto, and nearly everybody was familiar with the investment.  

But commodities were also fairly popular. Most people were familiar with the investment. And about 1/3 of the people we surveyed owned commodities. But I will note that we didn’t ask about every type of alternative investment.  

As we discussed, it’s a really broad field and it’s just kind of not feasible to ask about everything, so it’s hard to capture them all. So like you talked about, there are collectibles that’s a very common one for people like things like wine and coins or Pokémon cards. I certainly have Pokémon cards sitting in my parents’ closet. And a lot of people do view those as an investment, and there’s probably a decent group of people in the world who not only know about collectibles, but also probably have collectibles in some way. 

Cassidy Clement 

Yeah. I mean, there’s several different ways that people can kind of get into the alternative investment space, whether they realize it or not. But I guess more of a financially structured view on this next question that I ask you, you know, can anyone make an alternative investment or is it a little more per asset requirements that go into it?  

Meaning Crypto has a certain type of investor profile that needs to be met and commodities has a certain investor profile that needs to be met. How exactly do you know? Or can anybody kind of enter the room? 

Danielle Labotka 

Yeah. As you alluded to, and something that’s probably going to come up a lot today is that it depends on the investment. So actually, many alternative investments have a high minimum investment threshold, which means that the amount of money you need to just invest in the product at all can be quite high.  

So take for instance private equity, which we mentioned earlier, the minimum investment threshold for private equity can be in the hundreds of thousands of dollars to millions of dollars.  

And some of those situations you might need to be an accredited investor, which means that your net worth is over something like $1,000,000. It’s not that everybody can invest in every single different type of alt. There are some barriers to entry. But that being said, there are many big changes coming to finance because of advances in tech. And also different regulations and laws that are being moved around in the world that actually have been lowering the barrier to entry for some alternative investments.  

So for example, some apps might actually allow you to trade cryptocurrency with as little as a dollar. However, I think there is an important distinction here between can and should, right? So in our study, we also asked people why they wanted to increase or decrease their holdings in alts and the most common answer was that people were seeking to maximize their returns. Now you may be wondering why I’m bringing this up as like a bad thing. After all, like, aren’t we investing for returns in the first place?  

But the problem with focusing on returns is that it can lead to this phenomenon called returns chasing, which often entails buying things that are hot at the moment and dumping things that are not. And this is really one of those classic cases of the typical way that we think that serves us well in daily life is not serving us well in our investing lives because returns chasing is something that we want to avoid.  

Since studies on the issue have shown that it actually is quite costly, not only because you’re buying things when they’re at their most expensive and selling them when they’re they’re cheapest, but also because it racks up transaction costs. And another motivation that people might want to be a little wary of when it comes to should I invest in an alternative asset was the people kind of just discussed having this feeling of confidence in an asset and that’s why they wanted to be involved with it.  

And the problem with this is that the way that people tend to think is that we’re overconfident about our stance on things, even if we’re not an expert on the topic. And even if we don’t even have, like data to back us up. So perhaps you want to invest your money in collecting sneakers because you are really into sneakers and you feel pretty confident that there will be a continued market interest in them. 

So you actually view your sneaker collection as part of your long-term retirement plan. But this is where that overconfidence may be coming into play because when we look at other instances of things like this, you mentioned Beanie Babies, right? The Beanie Baby craze. Some people likewise thought that their Beanie Baby collection was going to be part of their retirement plan and that they would be able to sell them for hundreds of thousands of dollars more than they got them for. And that didn’t quite work out for them as expected. 

So being able to invest in an alternative investment is really just the first part of the equation. And the rest of the equation, which is the bigger part, is determining whether you should invest in an alternative asset.  

Cassidy Clement 

I think you mentioned a lot of really good pieces that tie kind of back into the behavioral conversation we were talking about earlier. So something to think about when it comes to the psychology within finance in general and also the general consumer view on the asset that you’re looking at is it more of the return chasing or the fear of missing out? FOMO is a huge thing when it comes to hot topics, if you will, of the day. Groupthink is another one.  

Is it kind of that you’re surrounded with other people who are interested in this area and that doesn’t necessarily reflect the majority of the market? It kind of reflects the group or the small niche that you’re exposed to. And then of course, more of the interest-based areas.  

Is it mainly because you have an interest in it that you are so confident? Or is it more the financial news you’re exposed to vs. the type of research that you’ve done? There’s many elements that can impact these types of investments when the financial metrics are not as easy to find as those that are conventional investments such as stocks and bonds. Where there are, at this point, maybe hundreds of years’ worth of metrics, data, and research that has been conducted on it, whereas crypto as we all know is relatively new.  

So it’s hard to make these rounded action decisions without having so much at your disposal on research, and that doesn’t mean that every conventional structured product research is always 100% correct. It’s just more so that the track record is there for people to look into a little bit more accessibly vs. knowing what to search for when it comes to the REITS, crypto or even these smaller interest-based sneakers, for example.  

I was into sneakers in junior high, but I can’t tell you right now what to look for for a resale value on your Jordan 11s that may be in the back of your parents’ closet. I’m not sure. But those are all really good points to think about if you’re deciding, hey is this something I actually want to put money into? Which kind of leads me to my next question determining how the investment is right for the user. Or the consumer, I guess in this case.  

Are there certain taxes on these investments that a consumer might say, oh, you know what, that’s not really for me. That bill may be too high or the risk of it going high or low, and then the bill on the taxation and the security or the investment itself won’t work with my budget. 

Danielle Labotka 

Right. You know, it’s really interesting that you mentioned like group thinking kind of all the different ways in which we’re sometimes insulated in the knowledge that we have about these things. And so actually, based on our study, we developed an exercise to help investors take a step back and determine if it’s right for them.  

So the first step that we actually have people take is just to evaluate how much do you know about the alternative investment you’re interested in? Like, do you know what the tax structure is? Do you know what the tax benefits are or aren’t? And so we have people take a step back and say, well, have I just heard of it? Or could I pick a definition out on a list? And if you can’t even define it for yourself, if I can’t say hey, you know, tell me what cryptocurrency is and you can’t really tell me, we encourage you to kind of hold off until you know more about the product.  

And when you’re holding off on that, you want to take time to learn more from trusted sources and finding out about tax information is really important. Because I think it’s something everybody should always assume is that if you’re making money, it’s going to be taxed in some way. And so, you know, some alts may not have the same tax benefits as conventional investments or they might have different ones. And so this comes back to ensuring that you know what you’re investing in. Always take time to research what taxes you’re going to have to pay. And when you’re going to have to pay them. After that, right, so okay, I get it. I feel pretty confident now. I took my time. I read as many sources as I could and I know how the taxes are going to work for my investment. I’m ready to go on to the next step.  

And so our exercise then says, well, okay, okay, so you’ve taken the time to figure this out. Now I want you to sit down and think about what your motivations are for this investment. Are you just interested in the currently hot returns or are you looking at motivations like the tax benefits associated with them or the diversification they bring your portfolio?  

So once you’ve thought about your motivations, you should sit down and write out how that motivation fits into your long-term financial goals. Something that we always encourage on our behavioral insights team on Morningstar is for people to really treat their financial goals as their North Star in their investing journey.  

Because a lot of times, being able to come back to the thing that really matters is going to help you avoid a lot of those common mistakes that people tend to make when things are exciting or scary or just confusing like alternative investments can be.  

So, for example, say that my goal is to get enough money for a down payment for a house in a couple of years. And I want to invest in Bitcoin because the returns are off the chart. And that sounds really great to me. But we do know that Bitcoin can be quite volatile, and if I did something like invest my down payment money in Bitcoin in like 2021 when it was really hot and went to pull it out in 2023 when it was not so hot, I’d be left with only a little bit of my original investment because of that volatility.  

So here we see that the returns may not be a good motivation given the time frame we’re looking at for my goal. So instead, some motivations that might be good in this situation is, you know, finding an investment that has good liquidity. So I can pull out my money when I need it because I found the perfect house. Or it’s something that yields decent dividends, so I can beat inflation while I’m waiting for that perfect house to show up. This might lead you to be like, okay, maybe this alternative asset isn’t right for me and this one is.  

Or it might be well, maybe a conventional investment is right or even a high yield savings account. I think just because you’re interested in an alt doesn’t mean that you have to do it once you’ve started to do the research. Keep an open mind.  

The last step that we encourage again comes back to that point that you made earlier of  getting more information and ensuring you’re not just listening to those who are already thinking like you and that’s to broaden your perspective.  

So, the last thing we say is that people tend to like to read things that we already agree with. It’s called confirmation bias. And it’s really nice, and sometimes it can feel really good, but not when you’re working with your finances. You want to make sure you’re doing the right thing here. So in this situation, we encourage you to seek out three sources that actually disagree with your investment decision.  

So say that I went through all the trouble of learning about REITs and how they function and then I’m like, okay, they align. The motivation here aligns with my financial goals so REITs look great to me. My next step is then to find people who are actually talking about why they’re not so great right now. And that final step is going to ensure that you have a well-rounded grasp on the decision before you actually make the plunge into that investment. 

Cassidy Clement 

That’s a really good point, actually. I’ve never thought about that from a financial viewpoint. In college, I remember doing research papers and some of the critical thinking exercises were finding something with an opposing view because then it makes you think about it from a different perspective, potentially refine or change your viewpoint.  

It’s kind of like a debate with yourself, in a way. And with finances, you’re right, because when it’s gone, it’s gone, for the most part. The house down payment is a great example. If you put it in at 60 and you come back for it, hoping that it’s 60 and it’s 15, that is a hard pill to swallow, especially if you’re looking to put a roof over your head.  

So it’s important to understand the taxation side of it. This is kind of I guess you could say the final step before the finish line because this matters the most. What regulations are around the alternative investments? Is it going to keep certain people out? Is it going to make certain people not want to even enter the pool of investment because of the potential red tape? What does that look like? 

Danielle Labotka 

Yeah. So on the whole actually, alternative investments tend to be less regulated than conventional forms of investments. And for some people this is an attractive. Like you can think of a number of people who are very interested in cryptocurrency because it isn’t regulated by a centralized government.  

But on the other hand, this means that you really need to do your own research. And ensure you understand what’s really going on with an investment opportunity because that lack of regulation also opens the door for people to scam other people. So you want to make sure that you’re really taking the time to understand what the regulations or lack thereof mean for you. And I think that’s something that we’ve talked about a lot is that there’s a lot to consider here! And you’re going to have to consider those same things over and over again for each form of an alternative investment, because they’re all different.  

And so you might be thinking that this sounds pretty complex and that’s because it kind of is. And alternative investments aren’t necessarily going to be right for every investor at any given point in time, especially for those new to investing.  

And so if you are really keen on this and you’re noticing that it’s really complex, some people might benefit from talking to a financial advisor before making that leap into alternative investments because there is so much complexity going on and there’s so much research associated with really understanding them. And as you pointed out, it’s not as simple as, oh, I can just look at how this stock has performed for the past 100 years. You have to really kind of dig sometimes to understand what you’re getting invested in.  

So I would say though, like regardless, it’s important to slow down and consider how these investments work with your current needs and also align with your goals.  

Cassidy Clement 

I mean, you put it right in the bullet points. Make sure it fits you, make sure it hits your goals, make sure that you give yourself a viewpoint that helps and hurts you for a moment to see what’s worth it for you. But this was great. Thank you for joining us, Danielle. 

Danielle Labotka 

Yeah. Thank you for having me. I loved getting to hear your perspective on these things. 

Cassidy Clement 

Yeah, this was great. So as always, listeners can learn more about an array of financial topics for free at ibkrcampus.com. Follow us on your favorite podcast network and feel free to leave us a rating or review. Thanks for listening everyone.