Alternative Investments: Explore Beyond Stocks and Bonds

Alternative investment is an all-encompassing term for any asset that differs from traditional stock and bond investments. An alternative asset could be a physical item like a valuable bottle of wine, a piece of art, or an office building. 

Although alternative investments can be pricey, they offer unparalleled portfolio diversification, which can be particularly important when investing after retirement. Alternative investments offer exposure to real estate, the commodities market, and even the art world. 

Greater portfolio diversification allows you to benefit from various market areas and can serve as a hedge when assets like stocks and bonds suffer. Using one of the best commodity trading apps may help offset inflation and other market risks. 

That said, alternative investments are largely unregulated and are more costly than traditional investments. It’s important to know the risks and rewards before investing. 

Types of alternative investments

Let’s explore the different types of alternative investments that may be worth adding to a diversified portfolio. 

Private equity

Private equity refers to capital moved into privately held companies or partnerships as an investment or a reorganization tactic. This strategy intends to make changes and then resell the company (or one’s ownership stake) at a profit.

A company could benefit from a cash infusion multiple times during its life, and private equity firms aim to seize those opportunities. However, average investors usually cannot participate in private equity opportunities requiring immense capital. The minimum investment for a private equity firm can be as low as $250,000 but is often more like $25 million with a 10-year time horizon. 

Real estate

Probably one of the most familiar alternative investments, real estate refers to the land or property owned by an individual. If you own your residence or even rent and sublet out portions of it, you’re already a real estate investor.

Real estate investments can produce a profit in three main ways:

1. Rental income
2. An increase in property values
3. Royalties for any discoveries made on your land, such as minerals or oil

Property values can increase due to surrounding development, your own improvements, or the location’s increasing desirability. But they can just as easily drop if trends go the other direction. You can also consider a real estate investment trust (REIT), which is publicly traded and in a more liquid way. 

You can invest directly or indirectly with the best real estate investment apps. 

Commodities

Commodities are physical materials and natural resources traded on the market, such as grains, oil, gold, and natural gas. 

When paper assets (the stock and bond markets) move one way, commodities tend to push the other, making them a popular hedge against inflation. For example, some experts recommend investing 5-10% of your portfolio in an alternative asset like gold because when the market suffers, its price soars, providing a cushion against loss.

If you’re invested in shares of a given commodity, you’ll receive dividends when it spikes in price. But if you own the item itself — considered by some to be a purer form of investing — you can profit only from its sale. 

You can invest in precious metals with the best gold IRAs and other commodity trading platforms. 

Collectibles

The options for what can be defined as a collectible are virtually endless. But in general, they’re tangible items in your possession that you enjoy but also hope will appreciate over time. That could be anything from antique jewelry to Zebra-patterned rugs.

Different types of collectibles go in and out of fashion. Try not to get caught up in crazes, which are rarely sustainable over long periods — Beanie Babies being a prime example.

The most commonly recognized collectibles include:

• Works of fine or decorative art (including jewelry)
• Numismatic coins or stamps
• Vintage cars and other vehicles
• Rare books
• Fine wines

Because collectibles aren’t traded on public exchanges, there’s no transparency to pricing or official mechanism to determine market worth. Aside from auction results, there are no published prices, as many dealers keep sales confidential. 

Ensure you know what you have, and try to get documentation to prove it. Both will prove invaluable when the time comes to find a buyer.

Derivatives

Derivatives are contracts between two or more parties built on speculation about the changing value of an underlying asset — an option being one of the most common examples. They can be used for risk management, pure speculation, or leverage.

For example, if it’s April and you’re a farmer hoping to sell your wheat crop in October, you might purchase what’s known as a futures contract to sell wheat at $5 a bushel. If the price of grain goes up to $7 in October, you’d be wise to let that contract expire and sell at the new price. But if it dips to $4, you could use your contract or sell it for a tidy profit.

The above description is how derivatives were initially designed. But they rarely work that way anymore, with actual assets being bought and sold. Instead, they operate more speculatively. Instead of a farmer insulating his grain harvest and shoring up his income, they’ve become much more popular with traders hedging their portfolios.

Cryptocurrencies

Cryptocurrencies are alternative digital assets. These high-risk coins and tokens are created and traded using blockchain technology, which can be accessed 24/7. Bitcoin is the most valuable cryptocurrency. It can be purchased with many of the best cryptocurrency exchanges. 

While cryptocurrency has continued to increase in popularity, with some investors turning a huge profit, it is extremely risky. Cryptocurrencies like Bitcoin and Ethereum aren’t backed by anything, as their value relies solely on supply and demand. There’s no guarantee that any cryptocurrency will appreciate in the long run. 

That said, investors with a high-risk tolerance may add cryptocurrency to a diversified portfolio to further mitigate risk and capitalize on potential market gains. However, don’t invest more than you are willing to lose. Also, be cautious of potential scams since the crypto world is rife with fraudulent and misleading investment opportunities. 

Benefits of alternative investments

• Portfolio diversification: Since alternative assets like commodities and real estate correlate little with traditional stocks and bonds, adding alternative investments can further diversify your holdings to limit risk and volatility. 
• Potential for higher returns: Alternative investments may offer higher returns because taking on greater risk can increase your chances of experiencing potentially higher wins or losses in your portfolio. This is referred to as the risk-return tradeoff. 
• Inflation hedge: Since alternative investments like real estate and commodities aren’t directly tied to the market, investing in these asset classes acts as a hedge against inflation to maintain purchasing power during economic uncertainty. 

Risks of alternative investments

• Illiquidity: Alternative assets, especially physical items like collectibles and commodities, generally lack liquidity. This means they are not easily bought or sold, making it more difficult to turn your investment into cash. 
• Complexity: Many alternative asset classes require greater knowledge and expertise on a particular subject or investment strategy. For example, to effectively invest in real estate, you must be knowledgeable in the real estate market, locations, strategies, and risks involved. 
• Higher fees: Alternative investments tend to require higher minimum investments and higher fees compared to traditional investments. These higher costs can make alternative investments less feasible for novice investors. 
• Lack of regulations: Whereas traditional investments are governed by strict disclosure regulations and protections against fraud, alternative investments put the onus on the investor. For example, if you purchase a piece of art and then determine it’s a forgery but can’t track down the seller, that loss is yours to swallow.

Who should consider alternative investments?

Alternative investments are best for investors with a high risk tolerance, long-term time horizon, and adequate portfolio diversification. Investors with extensive capital and experience dealing with complex financial assets also commonly invest in alternative assets. 

Sophisticated investors can make a lot of money in such an environment. But it requires sharp senses, a long time horizon, and patience for all the tedious complexities of investing in alternative investments like private equity, commodities, and collectibles. 

Without those well-honed skills —and a heaping portion of luck — alternative investments might be too high-risk for the novice investor. As an alternative (to the alternatives), consider getting your feet wet with publicly traded vehicles like individual stocks or funds that invest in the alternative asset classes.

How to invest in alternative investments

There is more than one way to invest in alternative investments. Depending on your chosen method, you may be associated with different strategies, risks, and benefits. 

• Direct investment: Purchasing physical assets like gold and other precious metals, real estate, or collectibles like artwork.
• Funds and ETFs: You can also consider investing in mutual funds or ETFs specializing in a certain alternative asset. Alternative asset funds are usually more affordable with less imposed risk. For example, if you’re interested in real estate, you can invest in a real estate investment trust (REIT). 
• Private placements: Accredited investors may be able to invest directly in private companies or funds. This option is not usually widely available to regular retail investors and may require substantial upfront capital.

Regardless of how you invest in alternative investments, it’s crucial that you thoroughly research the best strategies, possible risks involved, and other relevant information required to get the most out of your investment. Many alternative investments lack liquidity over the long term, so make sure you don’t invest money you will need access to in the near future. 

FAQs about alternative investments