What Are Alternative Investments?
Alternative investments are investments that don’t easily fall into one of the traditional asset classes (like stocks, mutual funds and bonds). Alternative investments typically have much higher levels of both risk and reward, and they typically come with higher investment minimums. Due to their higher degree of risk and lower levels of regulation, most alternative investments are held by high-value accredited investors.
The hedge fund industry has been using alternative assets as part of its investment strategy for decades. Now, thanks to changes in securities regulations, retail investors can now access these same opportunities.
While alternative investments may have additional barriers to entry, they can be used to add another layer of portfolio diversity to your holdings. Today, we’ll explore some of the most common alternative investments and explore investment strategies.
Types of Alternative Investments
There are multiple types of alternative investments, ranging from privately-managed hedge funds to diverse real estate investments. The specific type of investment you choose will dictate your risk level and minimum required investment. Popular types of alternative investments include:
- Real estate: This can include purchasing your own property, investing through real estate crowdfunding or buying shares of publicly-traded or non-traded REITs.
- Startups: Thanks to startup crowdfunding, the average retail investor can now buy equity in an early-stage private company. Individuals can also invest in private equity and venture capital funds to spread their capital across multiple vetted startups.
- Private credit: There are now multiple platforms available that allow the everyday investor to take the place of traditional banks and fund loans for consumers, businesses and real estate. These investments typically provide fixed income as loan payments are made.
- Art: While the multimillion-dollar price tags on bluechip art have made this asset class prohibitive to most investors without going through a hedge fund, there are now options to buy shares of iconic paintings or invest in art equity funds.
- Wine: Buying the right bottles of wine early can result in massive gains as the demand increases among wine enthusiasts. There are now platforms that give individual investors access to these investment opportunities in wine.
Alternative Investment Strategies
Alternative assets have traditionally had low correlation rates with the overall market at large. This means that in years when the market goes down, the value of alternative investments typically goes up. Alternative investments can provide a unique level of diversification to your portfolio. Certain hard assets (like gold and property) can also provide a hedge against inflation.
While alternative investments are often valued because they go against the traditional market, this can also make them a riskier bet for your portfolio. Most institutional investors have traditionally allocated a small percentage of their overall assets to alternative investments — on average, 10% or less. However, many hedge funds and pension funds are increasing their holdings in alternative assets to 25% or more.
Pros and Cons of Alternative Investments
Like any other investment, alternative investments have their own unique benefits and drawbacks. Understanding both the pros and cons that come with alternative investments is crucial.
Pros:
- More potential for profits: Alternative asset managers can often take risks that standard investment managers who oversee assets with strict SEC regulations cannot. If the investment turns out to be successful, it can compound returns.
- Diversified portfolio: Alternative investments add a unique layer of diversification to your portfolio. This can help protect your investments in the case of a recession or period of his market volatility.
- Often work counter to the larger market: The value of alternative investments tends to increase when the overall market is bearish. Alternative investments can provide a unique hedge against a market downturn.
Cons:
- Higher risk: Many alternative investments lack the same SEC regulations as traditional investments. While this can work to your advantage, it can also mean greater loss if you make a bad investment.
- Less liquid: If you have an emergency bill that you need to cover quickly, you typically won’t run into much trouble if you are forced to sell your mutual fund, stocks or ETFs. Liquidating an alternative investment can be a more time-consuming and intensive process, as buyers typically aren’t readily available on the private market when compared to standard investments.
- Higher entry point. To get started with an alternative investment, you’ll typically need a large amount of capital or to already be an accredited investor. This high barrier of entry can make alternative investments significantly more difficult to access than traditional assets.
What are alternative investments used for?
More investors are increasing their asset allocation to alternative investments to diversify their portfolio, increase returns, generate income and hedge against stock market volatility.
What are the safest alternative investments?
While the safest alternative investment portfolio is diversified across multiple alternative asset classes, the safest alternative investment has historically been tangible assets like real estate.
