Incorporating Alts Into Your Portfolio: How to Compare Different Investment Opportunities

If you’re considering jumping into the world of alternative investments, maybe you’ve already started exploring your options. From cryptocurrency and commodities (like gold and silver) to collectibles and real estate, the alts world is full of many exciting options.

The question is, how do investors compare different investment opportunities to find the one that’s right for them? This can be especially challenging when venturing into new territory and away from familiar options, like stocks and bonds.

Trying to compare the potential returns of cryptocurrency against self-storage investing is akin to comparing apples to orange-flavored Jell-o (two things that are not even remotely similar). Each has its own unique risks, liquidity levels, and return potential.

Let’s take a look at what risk-adjusted returns are, and what methods investors can use to accurately evaluate and compare investment options.

Understanding Risk-Adjusted Return

Risk-adjusted return measures the returns or potential returns of an investment against the amount of risk represented during the investment period.

Say you have two investments (one in crypto and the other in self-storage), and they each deliver the same returns during a six-month period. Whichever investment is determined to have the lowest risk (in this case, the self-storage investment) is deemed to have a better risk-adjusted return.

This is important because, generally speaking, the riskier an investment is, the higher the potential returns should be. So in this example scenario, you’re better off with the self-storage investment opportunity because it’s lower risk than the cryptocurrency — yet yields similar returns. 

What Is the Sharpe Ratio?

To measure the risk level of an investment, we use the Sharpe ratio — which you may have heard of before, as it’s commonly used for evaluating opportunities in the stock market. The Sharpe ratio is a mathematical formula used to measure an investment’s risk-adjusted performance.

The Sharpe ratio was created by Nobel Prize winner William F. Sharpe in 1966.[1] Its primary purpose is to help investors understand if the excess returns they’re experiencing over time can be attributed to savvy and prudent investment decisions, or simply a combination of luck and risk-taking.

Here’s what it looks like:

(Return of portfolio) - (risk-free rate) / standard deviation

The first half of the equation represents the difference between realized or expected returns over time and a benchmark (like the performance of a specific investment category). The “standard deviation” refers to how much returns deviated over that same length of time — which measures risk and volatility.

Put simply, the Sharpe ratio allows investors to compare either historical or projected returns against the investment’s benchmark while accounting for the variability of those returns. 

How to Decipher the Sharpe Ratio Formula

If a lucky Gen Z investor strikes it rich with the latest meme stock and his portfolio outperforms Warren Buffett’s for a short period of time… does that mean he’s a better investor? The Sharpe Ratio will help confirm that no, that is not the case. Rather, one investor got lucky with his choice of risk and potential reward for a short while.

The higher the Sharpe ratio is for a portfolio, the better its risk-adjusted performance is. If the Sharpe ratio is negative, then that means the benchmark rate used to compare the portfolio’s performance is greater than the historical (or projected) return. Or, worse yet, the investment’s return is (or is expected to be) negative.

Interested in Expanding Your Portfolio?

Having a way to compare two or more investment opportunities is incredibly important, especially when the level of risk varies. The good news is, our team of real estate experts are well-equipped to make these evaluations and provide investors with the information needed to make informed decisions.

If you’re interested in learning more about our next investment opportunity, now’s the time to join our Investor Portal. Be the first to know about upcoming acquisitions and gain access to exclusive insights.

Sources:

[1] The Sharpe Ratio