Alternative investments, those outside the traditional stock and bond categories, have moved from the domain of institutional investors and the ultra-wealthy into the portfolios of sophisticated individual investors. Real estate investment trusts trade on public exchanges with daily liquidity. Private credit funds have become more accessible through interval funds and business development companies. Commodity exposure is available through ETFs. Infrastructure and real assets have entered the investable universe through various structures.
The case for alternatives in a retirement portfolio rests on two potential benefits: diversification through low correlation with traditional assets, and inflation protection through exposure to real assets. Both are genuine in some circumstances and overstated in others. The liquidity risk, fee complexity, and performance variability that accompany most alternative investment structures are real costs that must be weighed against the diversification and inflation benefits.
For retirees who are drawing income from portfolios, the liquidity dimension of alternatives deserves particular attention. A retirement portfolio that is partially illiquid creates a forced selling problem during downturns: the liquid assets must fund withdrawals even when their prices are most depressed, because the illiquid alternatives cannot be tapped on short notice. Understanding the specific liquidity terms of any alternative investment is not optional for a retiree.
This paper covers the major alternative asset categories relevant to individual investors, the realistic diversification and inflation benefits each provides, the liquidity and fee considerations, and the framework for deciding whether alternatives add value to a specific retirement plan.
Real Estate Investment Trusts are companies that own income-producing real estate, from apartment complexes and office buildings to data centers and cell towers. REITs are required by law to distribute at least 90% of their taxable income to shareholders annually, which produces relatively high dividend yields. They trade on public exchanges with the same daily liquidity as common stocks.
REITs occupy a hybrid space between stocks and bonds. They provide equity-like returns over long periods through a combination of dividends and property appreciation, but they also carry equity-level volatility and decline significantly in bear markets. In 2022, the REIT index declined over 25%, while REITs had previously declined over 40% in the 2008-2009 financial crisis. They are not a defensive asset class.
The correlation between REITs and the broader stock market has increased significantly over the past two decades as REITs have become more widely held by institutional investors and index fund managers. The diversification benefit that REITs provided in the 1990s, when they were less correlated with broad equities, has diminished. REITs today behave much more like the stock market than like a separate asset class, particularly during periods of market stress when correlations tend to converge.
Real estate does provide meaningful inflation sensitivity over long periods, as property values and rents tend to rise with inflation over time. This makes REITs a potentially useful inflation hedge in a long-horizon retirement portfolio, even if the near-term volatility is comparable to equities.
Private credit encompasses loans made directly to businesses outside the public bond market. Business development companies are publicly registered investment companies that primarily make loans to, or equity investments in, private middle-market businesses. They are required to distribute most of their income to shareholders, producing high yields.
BDCs provide exposure to private credit with relatively accessible minimums and quarterly or daily liquidity for most public BDCs. The trade-off is that private credit carries more credit risk than investment-grade bonds, higher fees than most bond funds, and exposure to the specific companies in the portfolio, which are often smaller, more leveraged businesses than those in public debt markets.
Many alternative investment strategies are now available through interval funds, which offer periodic liquidity, typically quarterly, rather than daily redemption. Interval funds invest in illiquid strategies including private credit, real estate, infrastructure, and other assets that don't have daily market prices. They provide access to returns that were previously available only to institutions, but with significant liquidity restrictions.
For retirees, interval fund liquidity terms deserve careful scrutiny. A fund that allows quarterly redemptions of 5% of assets may not be able to process a redemption request quickly if the fund is facing high redemption demands simultaneously. The liquidity available during normal markets may not be available during the stressed markets when liquidity is most needed.
Commodities, including energy, agricultural products, and metals, have historically provided inflation protection over long periods. When consumer prices rise, commodity prices often rise alongside them, partially because commodities are inputs into the prices of many consumer goods and services. Gold has a long history as a store of value during periods of currency debasement and inflation.
However, commodity returns over long periods have been volatile and inconsistent. A broad commodity index returned very little over the decade from 2012 to 2022, before surging sharply in 2022 due to supply disruptions. The inflation hedging benefit is real but arrives episodically rather than smoothly, and commodities generate no income while they wait for inflationary periods.
Infrastructure investments, in airports, toll roads, pipelines, utilities, and similar assets, provide exposure to long-duration, inflation-linked cash flows from assets that are often regulated or essential. Infrastructure has historically shown lower correlation with equities than REITs and lower volatility, making it a more genuine diversifier in theory.
Public infrastructure exposure is available through dedicated ETFs and closed-end funds. Private infrastructure, accessed through limited partnership structures, is available to accredited investors and provides more direct exposure but with multi-year lockups and high minimum investments.
Roger Ibbotson and colleagues have produced research on alternative asset class inclusion in diversified portfolios, examining the correlation and return characteristics of various alternatives over long periods. Their work generally supports the inclusion of alternatives with genuinely low correlation to public equities, while noting that the correlation benefits often diminish during market stress periods when diversification is most needed.
The CFA Institute has published research examining the reported returns of private market investments, including private equity, private credit, and private real estate. Their analysis highlights the challenge of performance measurement in private markets, where appraisal-based valuations can smooth reported returns and obscure the true volatility of the underlying assets. Investors who compare private market reported returns to public market returns may be comparing apples to oranges.
Vanguard has published balanced analysis on alternative investments, acknowledging the theoretical diversification and inflation protection arguments while noting the practical limitations including higher fees, less transparency, reduced liquidity, and the mixed historical evidence on whether alternatives have actually delivered on their theoretical benefits for individual investors. Their research is one of the more intellectually honest treatments of this topic from a major investment firm.
Holding REITs, commodities, private credit, and international stocks alongside domestic stocks may look like diversification, but if these assets are all correlated with market risk during downturns, the apparent diversification provides less protection than it appears. True diversification reduces portfolio volatility. Category proliferation that doesn't reduce correlation during stress periods is not genuine diversification.
Alternative investment products frequently carry multiple fee layers: management fees, performance fees, fund-of-fund expenses, platform fees, and transaction costs. The total cost of accessing a private credit strategy through an interval fund can easily reach 2% to 3% annually, which must be overcome before any return benefit is realized. For a retirement portfolio where 0.5% differences in fees have compounding impact over decades, the fee structure of alternative investments deserves rigorous scrutiny.
A retiree who holds 30% of the portfolio in illiquid or semi-liquid alternatives faces a structural problem during a market downturn: the liquid portion of the portfolio must fund all withdrawals, potentially depleting the liquid assets at accelerated rates while the illiquid positions cannot be accessed. Liquidity requirements in retirement are higher than during accumulation, and the alternative allocation should reflect that.
This establishes whether the alternatives have a defined purpose or were added without a clear rationale.
All-in cost transparency is essential for evaluating whether the expected benefit justifies the cost.
This directly addresses the retirement-specific liquidity concern.
Historical performance review keeps the allocation grounded in evidence rather than marketing claims.
As the planning horizon shortens and income needs become more immediate, the appropriate alternative allocation typically decreases.
The retirement planning calculator at plan.johnkoyle.com was built to model exactly the dynamics discussed in this paper. Alternative investments in your portfolio affect the Gross Annual Return and volatility assumptions that drive the Monte Carlo simulation in the retirement calculator at plan.johnkoyle.com. When modeling a portfolio with significant alternatives, work with your advisor to determine appropriate blended return and standard deviation assumptions that reflect the actual characteristics of your holdings, including the fee drag that reduces net returns from alternatives. The simulation will then reflect a realistic picture of how the alternatives-inclusive portfolio performs across the range of possible return sequences.
John Koyle, AIF®, is the Co-Founder of Red Cedar Wealth Advisors, headquartered in Pocatello, Idaho. He holds the Accredited Investment Fiduciary (AIF®) designation, awarded by the Center for Fiduciary Studies (Fi360), which signifies completed coursework, a rigorous examination, and ongoing continuing education in fiduciary responsibility and prudent investment practices.
John serves individuals and families in or approaching retirement throughout eastern Idaho, the Pacific Northwest, and across the country via Zoom. Clients work directly with John, not a junior team. Red Cedar Wealth Advisors operates under Osaic Wealth, Inc. (Member FINRA/SIPC) and Osaic Advisory Services, LLC for investment advisory services.
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