Does This Investment Belong in Your Portfolio? Here’s How to Decide.

If it feels like there’s a new investment idea popping up every week, you’re not imagining it. From cryptocurrencies and thematic ETFs to private placements and managed futures, today’s investment landscape is overflowing with options. But just because an opportunity sounds promising, or everyone else seems to be getting in, doesn’t mean it’s the right fit for your portfolio.

So, how do you decide what’s worth considering? Before jumping on the latest trend, take a step back. The key is to understand the role a potential investment would play in your portfolio and overall financial plan. Then, weigh its benefits against its drawbacks to evaluate the merits of the potential opportunity. A thoughtful, repeatable process can help cut through the noise and keep you focused on what matters most: building a portfolio that supports your long-term goals.

Start With Purpose: What Role Is the Investment Meant to Play?

Every investment should have a reason for being in your portfolio. That reason usually boils down to one of two things:

1. Increasing expected returns
2. Managing risk

If the goal is higher returns, there should be a solid case for why the investment is expected to deliver. For example, owning stocks gives you a claim on a company’s future cash flows. Bonds offer interest payments and a return of principal. However, if an asset, such as a cryptocurrency, has no inherent cash flow or income, it becomes more challenging to justify from a return standpoint. If an asset lacks a sound foundation for delivering a positive expected return, it should give investors pause.

On the other hand, if the investment is intended to reduce risk, consider how it achieves this. A risk-management investment should help clarify your future financial picture, not make it murkier. For example, an asset class whose returns are correlated with inflation but are much more volatile than changes in the Consumer Price Index may not be an effective risk-management tool. You may be hedging against unexpected inflation, but still increasing uncertainty over future consumption due to the volatility.

Adding a new investment can also reduce overall portfolio risk if it genuinely increases diversification. However, this extends beyond simply having a low correlation with your existing holdings. The more relevant question is: Does this expand your opportunity set?

For example, moving from a portfolio of only U.S. stocks to one that includes international equities or bonds opens you up to more of the global market (which, for context, totals over $200 trillion across stocks and bonds). That’s a meaningful diversification benefit. On the other hand, investing in a niche thematic fund may provide you with more exposure to companies you already own in broader indices.

The Other Side of the Equation: What Are the Drawbacks?

The benefit of adding something to your portfolio must outweigh the drawbacks. No investment is free. And we’re not just talking about fees (although those matter, too).

High costs can quickly erode potential returns, particularly in strategies that charge performance fees or have complex and expensive structures. Traditional equity and fixed income mutual funds and ETFs have a transparent pricing structure, typically charging a flat percentage of assets. Other asset classes may include a performance fee, which could incentivize the fund manager to behave in ways that are inconsistent with your investment objectives.

Less obvious is the risk of adverse selection, when the best opportunities are only available to a select few, and everyone else gets what’s left over. Getting behind the “velvet rope” doesn’t always mean you will access the “best” investments. This challenge is compounded by high minimum investment thresholds, which may prevent proper diversification within that asset class.

Complexity is another potential drawback. If you don’t fully understand how an investment works, you’re more likely to abandon it when it underperforms. And all investments will underperform at times. Sticking with your plan often comes down to how well you understand why you own something in the first place.

And let’s not forget the risk of regret. Adding a new investment often means selling something you already have. If you sell something to make room for the new shiny object, and that original investment then takes off, you might be left second-guessing your decision. This is one reason why having a consistent evaluation process is so important.

Real-World Examples (and What We Can Learn)

• Bitcoin: The media fanfare around Bitcoin leaves many investors wondering if they should invest. However, it is unclear why holding Bitcoin should have a positive expected return. Bitcoin lacks a clear mechanism for generating returns and is extremely volatile. It offers no claim on future cash flows (like a stock) and makes no promised interest payments (like fixed income). It’s hard to see how this helps reduce uncertainty in retirement. Future returns from simply holding Bitcoin depend on it appreciating in value compared to another asset, which is the definition of a speculative investment.
• Managed Futures: Managed futures funds typically hold diversified futures contracts tied to various stock and bond indices and are often touted as diversifiers for traditional asset classes. While they may have low correlations to traditional equity portfolios, these investments do not expand an investor’s opportunity set since they do not offer exposure to asset classes outside the traditional portfolio components. High fees are another consideration, as they will erode an investor’s performance.
• Thematic Funds: Thematic funds represent a broad class of investment strategies that provide exposure to narrow subsets of the market, such as specific sectors or industries. While this investment strategy may feel innovative, it often overlaps with existing holdings and relies on market timing, which has a poor long-term track record.

Final Thoughts: Ask the Right Questions

Adding something new to your portfolio should never be an impulsive decision. Each investment deserves scrutiny and an evaluation of its upside, cost, and how it fits into the broader picture. By asking the right questions, you can make better, more confident decisions and avoid costly missteps. Because when it comes to building your portfolio, it’s not about what’s trending. It’s about what works for you and your overall plan.