Real asset investment refers to investing in physical, tangible assets such as real estate, infrastructure, timberland, farmland, commodities, etc. Compared with traditional financial assets like stocks and bonds, real assets have some unique characteristics that make them a worthwhile investment option. In this article, we will explore the pros and cons of real asset investing so investors can make informed decisions.
Real assets can provide portfolio diversification benefits
One of the biggest appeals of real assets is diversification. Real asset returns have low correlations with stocks and bonds. Adding real assets to a portfolio can reduce overall risk thanks to diversification. For example, commodities like gold often zig when stock prices zag, helping smooth out returns over market cycles. Real estate also tends to be less correlated with equities. The diversification benefits of real assets allow investors to improve risk-adjusted returns.
Real assets provide inflation hedging abilities
With inflation recently hitting multi-decade highs, real assets also attract investor attention thanks to their inflation-hedging abilities. When inflation rises, the values of financial assets like stocks and bonds often decline. But real asset values tend to keep pace with inflation, providing a hedge. For example, inflation often drives up commodity prices and rents from real estate. This inflation protection is valuable for long-term investors seeking to preserve purchasing power.
Real assets can generate stable income streams
Many real assets generate steady income streams for investors. For example, real estate investors earn rental income from tenants. Infrastructure assets like toll roads or pipelines produce cash flows akin to dividends. These income streams are valuable for investors needing current income, like retirees. They also provide downside protection compared to growth-focused financial assets reliant on capital appreciation.
Illiquidity risk is a key real asset drawback
While real assets have benefits, they also carry risks. The biggest is illiquidity risk, meaning real assets can be difficult to sell quickly. For example, selling a property or piece of infrastructure can take months. Real asset markets tend to be thin, with large bid-ask spreads. And transaction costs like brokerage fees are higher. So while adding some real assets can diversify a portfolio, investors should be cautious not to overload on them.
In summary, real assets like real estate and commodities can provide portfolio diversification, inflation hedging, and income generation. But illiquidity risk is a key downside to weigh. As with any investment, real asset allocation should be tailored to an investor’s specific objectives and risk tolerance.