Alternative Investments: Your Guide to These Diverse Assets
When you think of conventional investments, stocks and bonds likely come to mind right away. Experts recognize cash as the third investment in the conventional category, with all other investments classified as alternative assets. Learn more about alternative investments to up your finance game.
- An alternative investment is an investment in any asset besides bonds, stocks, or cash.
- While many alternative investments exclude individuals outside those with the highest net worth, others are becoming more accessible to the casual trader.
- Types of alternative investments include but are not limited to private equity, hedge funds, venture capital, commodities, real estate, limited partnership, intellectual property, tax liens, and legal settlements.
- You can purchase many alternative investments through your existing broker, advisor, or financial institution. Some automated online investing platforms also offer this service.
- Benefits of alternative assets may include preferential tax treatment, a high level of control, and potentially high profits.
- Downsides of these investments include the lack of liquidity and the high risk level.
What Is an Alternative Investment?
Any investment outside of cash, stocks, and bonds is considered an alternative investment. Common examples include tangible assets, commodities, real estate, hedge funds, derivative contracts, art, antiques, managed futures, venture capital, and private equity.
These assets generally appeal to wealthy individuals, professional investors, and institutional investors who aren’t deterred by their high risk, limited regulation, and complexity. However, individual investors without the net worth necessary to invest directly in these products can purchase shares in alternative mutual funds and exchange-traded funds (ETFs).
What Are the Different Types of Alternative Investments?
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Each type of alternative investment has unique characteristics, so it’s important to carefully research the alternative assets of interest. Some of the most common choices include:
- Commodities, including investments in coffee, corn, oil, precious metals, ethanol, natural gas, soy, cocoa, sugar, wheat, and other natural resources. You can invest in commodities to hedge your bets and protect profits against inflation. These assets are bought and sold on the futures market.
- Private equity, in which you invest in a company that does not trade on the public markets. You will see a return on your equity investment only when the company finds a buyer, merges with another entity, or issues an initial public offering. Investing in a private company may also be a good fit if you want to participate in business operations and help guide its decisions as an early shareholder.
- Venture capital, which is a subset of public equity in which you invest in a company that’s poised for stratospheric growth in hopes of going along for the ride.
- Hedge funds are alternative investments designed to drive capital using various advanced market strategies.
- Real estate, including residential and commercial investment properties as well as shares in private real estate investment trusts (REITs). However, some REITs do trade on the public market. You can also invest in a real estate development corporation or real estate limited partnership, or buy and sell mineral rights to land. Real estate is one of the most popular alternative investment assets because it appreciates over time for potentially impressive returns. However, factors like neighborhood property value declines and down housing markets can quickly turn profit into loss.
- Master limited partnerships, which allow you to purchase shares in diverse construction projects like amusement parks, films, aviation, utility infrastructure, and other major capital expenditures.
- Tax lien certificates, in which you pay off the tax debt on a property that’s set for tax sale. In most jurisdictions, the property owner has a legal obligation to repay you with interest or you have a right to exercise your lien on the home.
- Trademarks, patents, copyrights, and other forms of intellectual property.
- Private mortgage investing, in which you offer a loan to a property buyer that pays interest over up to five years. This reduces risk because the home serves as collateral and you only lend up to 70% of the property’s market value. However, craft a careful contract to avoid losing your shirt with this type of investment.
- Structured settlements, in which you pay a lump sum to a person receiving monthly checks for a personal injury or similar claim. In exchange, you receive his or her settlement payments, which are regulated by insurance. Despite the low risk, this alternative investment lacks liquidity.
- Farmland, which you can hold for a profit based on growth, sharecrop, or lease. With this niche investment, you should have at least some land or farming experience or partner with someone who does. This is also a long-term plan that takes at least five years to produce returns.
- Franchises, which allow you to benefit from the name recognition of a major brand while owning your own company and either operating it or outsourcing management.
How Do Alternative Investments Work?
You can start putting funds in alternative investments through your existing financial advisor or institution. Some digital roboadvisors also allow you to trade alternative assets. However, they don’t offer the professional advice you may need as you get your feet wet with these high-risk investments.
If you want to start slow, consider so-called ‘liquid alternative’ assets like mutual funds and ETFs. These products take some of the risks out of alternative investments by providing financial reports and a prospectus that offers transparency to traders. In addition, ETFs and mutual funds are subject to regulation by the Securities and Exchange Commission (SEC).
When you decide to invest in a specific alternative asset, do careful research and review its implications with your advisor so you understand how this investment fits into your overall financial plan.
What Are the Advantages of Alternative Investments?
Some of the best reasons to consider trading alternative assets include:
- Retaining more control over investment holdings than you can achieve with common stocks and bonds.
- Distinctive knowledge in a particular area that gives you an advantage when trading a specific alternative investment, such as a long career in the gas industry for a utilities trader, for example. You might also have an interest in a particular area, such as tech, and want to support innovation in that area by providing venture capital.
- Specific market conditions that make it the optimal time to invest in a particular asset, such as those who benefited from the real estate bubble of the late 2000s or the dotcom boom of the 1990s.
- The tax advantages created by certain alternative investments, which are often preferable to the tax treatment of traditional investments.
What Are the Best Alternative Investments?
Some of the most promising alternative assets in the current market include:
- Gold bullion, which diversifies a traditional stock and bond portfolio to shield it from market ups and downs. Investing in gold can also shield you from the effects of inflation.
- Cryptocurrencies, sometimes called ‘digital gold’ by investment experts because of their comparatively high value. Do your research and choose a currency with a proven track record, such as Bitcoin.
- Private debt, which lacks liquidity but can provide profits of up to 10%. Many investors enter several such contracts to create streams of income with staggered payment dates.
- Art and antiques, consistently ranked as a top asset class for those who can afford to wait 30 to 50 years for a sizable payout.
What Are the Potential Downsides of Alternative Investments?
A lternative assets will not produce returns for up to 10 years. Investors cannot access the funds during that time since these assets are not freely traded on traditional markets.
These investments also carry high fees of up to 2% upfront and up to 20% at fund distribution. For this reason, it’s important to choose alternative investments with a proven performance record since they cannot be evaluated by standard stock market metrics.
Some alternative assets also create complicated risks you may be unaware of when new to that type of investment. For example, if you buy certain types of alternative investments through your individual retirement account (IRA), you may have to establish the IRA as its own business entity which subsequently must pay separate business taxes.