Alternative Investments: Types, Benefits, Risks

Alternative investments (also called alternative assets) are investments that are not traditional stocks, bonds or funds. They include instruments such as derivatives, cryptocurrency, NFTs, precious metals, collectibles, commodities, real estate or private equity.

Alternative investments often have these characteristics in common:

• They are less regulated than traditional investments.

• They tend to be more difficult to sell.

• Their price changes may not correlate very much with price changes in the stock market. That means if the stock market is down, the value of an alternative asset may not also go down. Likewise, if the stock market is up, the value of an alternative asset may not also go up.

• They tend to carry more risk than traditional investments. All investments should be approached with scrutiny, but “alts” deserve an extra degree of caution. One popular guideline is to invest no more than 10% of your portfolio in higher-risk investments.

Here are eight types of alternative investments that may be worth exploring.

Derivatives are investments that are linked to an underlying asset, commodity or index. There are several types of derivatives, including futures and forex.

• Futures are contracts to buy or sell a particular asset on a set future date for a set price. Futures contracts may obligate the buyer to take physical delivery of the asset on the expiration date, so to avoid having a truck of corn show up on your doorstep, you may have to sell the contract at a significant loss.

• Foreign exchange trading, or forex trading, is speculative investment in different currencies. For instance, if you believe the U.S. dollar will rise and the euro will fall, you could exchange euros for U.S. dollars. Most traditional brokerages don’t offer access to forex, so you’ll need to look into a forex broker if you want to start trading international currencies.

Cryptocurrency is a form of digital currency. There are many different crypto coins, such as Bitcoin or Ethereum. You might be able to use crypto to pay for things, or you can use it as an investment by buying it in the hope that it will increase in value over time.

• Some online brokerages allow crypto purchases. However, some investors store their crypto in a potentially more secure place than an online exchange: a crypto wallet. Storing your crypto yourself may make you less vulnerable to security breaches, but it comes with some risks. Learn more about how to buy cryptocurrency.

• Digital assets, such as cryptocurrencies and nonfungible tokens (NFTs), are supported by blockchain technology.

• If you want exposure to the crypto market without directly owning crypto, you can consider crypto stocks. These stocks are involved in the crypto market; for example, they may create equipment to mine cryptocurrencies or operate crypto exchanges. You can also look into Bitcoin ETFs, which hold a large amount of Bitcoin and track the price of Bitcoin.

Nonfungible tokens, or NFTs, are records of ownership of an original digital file. That file can be a piece of digital art or an item from a video game, and each NFT is unique. NFTs have largely declined in value since 2021, when they were making headlines.

Precious metals, such as gold and silver, have been valuable for a long time. Precious metals can also sometimes function as a hedge against inflation in a well-diversified portfolio.

There are several ways to invest in precious metals:

• You can buy the metal itself, typically in the form of bullion (think bars or coins) or jewelry. Bullion may be tempting — who doesn’t want a bunch of gold bars or necklaces lying around? But it’s difficult to store and sell.

• Some brokers, such as Fidelity and Interactive Brokers, allow you to purchase precious metals through them. These brokers can send the gold to you or hold onto it for you.

Collectibles, such as wine or fine art, can be difficult to secure and store, and they can be difficult to sell. Unless you’re well-connected in a particular collector’s industry, finding a buyer for your antique sculpture or vintage muscle car when you’re ready to cash in may be challenging.

Commodities are raw, physical products such as oil, wheat, gold or corn. Investing in commodities may have some overlap with a few of the other categories listed here. For instance, you can invest in commodity futures, or you can purchase precious metals, which are technically commodities. You can also buy commodity stocks or commodity ETFs.

There are several ways to invest in real estate, including REITs, or real estate investment trusts, utilizing a real estate investing platform or purchasing actual property.

REITs are similar to mutual funds in that they are companies, but they specifically own, operate or finance income-producing properties, such as apartment complexes that generate rent. REITs must pay out at least 90% of their taxable income to shareholders in the form of dividends, creating a potential revenue stream for investors^[0]

Real estate crowdfunding investment platforms have made investing in real estate far more accessible for the everyday investor. These platforms combine your money with other investors’ money so you can access private REITs and private property investments that historically have only been available to accredited investors (though some of these platforms are also only open to accredited investors).

If you have the capital, you can invest in actual real estate properties. This option may be attractive to those who can afford the startup costs (such as a down payment and any upgrades) and prefer to invest in something physical. The downsides include the risk of putting a large proportion of capital into one property, having to pay someone to manage and maintain the property, or having to do it yourself.

Private equity is exactly what it sounds like — equity that comes from private investors. Typically, the only way to access private equity is through a private equity firm, and the investments are often only open to accredited investors who can meet a very high minimum investment.

There are a handful of ways to invest in the alternative investments covered here, but buying alts typically boils down to one of three options:

2. Investing in a company that invests in the asset or is involved in its production.

3. Investing in a fund that holds lots of those companies.

For example, you can buy raw gold, stock in companies related to gold, or a gold ETF.

Buying alternative assets may be trickier than buying traditional assets. You can buy some alternative investments from a brokerage; others, such as futures and forex, typically require a special account. You can find crypto on crypto exchanges, access real estate crowdfunding through individual platforms, and buy collectibles at auctions or private sales. If you want exposure to an alternative investment through a stock or fund, you may need to have a brokerage account to do so.

Diversification. Diversification helps spread risk out across different industries, sectors and geographies. For example, if the tech sector is up and the oil industry is down, and you’re invested in both, you can smooth out the highs and lows of each. Alternative investments provide investment diversification, especially because their ups and downs may have lower correlation to the ups and downs of traditional investments.

Potential reward. This is one of the most attractive parts of alternative investments: They have the potential to bring in big financial gains. But in order to realize those large gains, you have to pick the right investment at the right time. And people, even investing professionals, often get it wrong and lose money.

Access. Until recently, alternative investments were only available to accredited investors or those with a high net worth. Now, there are more ways than ever for everyday investors to get access to some of these investments.

High Risk. Alternative investments almost always carry more risk than traditional investments such as stocks or bonds.

Illiquid. With many types of alternative investments, you may not be able to get your money out right away.

Less regulation. Many alternative investments are less regulated by the SEC than traditional assets.

Storage. Some alternative investments, such as precious metals, crypto, and collectibles, come with the added difficulty of storing them.

The best alternative investments to stocks will depend on your existing portfolio. For most people, a well-diversified stock-based portfolio can help build wealth over time.

For example, the average stock market return, as measured by the S&P 500 index, is about 10% per year for the last 30 years. Some years are higher and some years are lower, but over time, S&P 500 index funds have returned about 10%, not accounting for inflation. Knowing that, you can start to compare that to the performance of alternative investments.

Since 1972, on average, the FTSE NAREIT All Equity REITs index has returned an 11.3% total annual return. That’s not to say that REITs always outperform the S&P 500, but it does show over 50 years of strong performance.

Since 1969, gold has had a median average closing price of about $384 per ounce, and in 2024, gold’s average closing price topped $2,000 per ounce. That sounds great, but gold’s average annual return from the last 30 years was 6.7% — significantly less than either the S&P 500 or REITs. Gold can, however, serve as a hedge against inflation.

Every investment has pros and cons. That’s why it’s so important to consider potential alternative investments against your existing portfolio.

Alternative investments can be exciting, and they can help diversify your portfolio, but they also come with particular challenges and risks. If you’re curious about alternative investments, it’s worth doing your homework to see how they might complement your existing investment portfolio. If you don’t already have an investment portfolio composed of more traditional assets, it may be better to focus on building that first.