What Are Alternative Investments?
Alternative investments are nontraditional investments beyond the more typical stocks, bonds or mutual funds. No matter if you have short-term or long-term strategies, the main reason for investing money in alternative assets is to own some real assets that don’t move in lockstep with the stock and bond markets.
Read: 3 Things You Must Do When Your Savings Reach $50,000
About Alternative Investments
Though most alternative assets such as property, hedge funds or other commodities are less liquid than some investments, they do tend to have fewer restrictions or regulations placed upon them by the U.S. Securities and Exchange Commission. The reason these investments and assets are considered to be alternatives is because they don’t get filed in the categories of equity, income or cash.
9 Alternative Investments To Consider
Alternative investments are not all exotic. The important thing from a portfolio diversification perspective, whether it’s your pension fund or other financial assets, is that their values don’t correlate directly with stocks and bonds. Here’s a look at nine alternative investments, how they operate and what type of investors might be interested in owning them.
Hedge funds
Precious metals
Futures
Commodities
Real estate investments
Collectibles
Crowdfunding platforms
Venture capital
Private equity
1. Hedge Funds
Hedge funds are something like mutual funds on steroids. Hedge funds take money from investors and buy securities, just like mutual funds, but the success of a hedge fund is determined more by a manager’s skill than the performance of the markets overall.
Pros
Generally less regulated and restricted than mutual funds
Can typically buy nearly any investment they want
Often run by superstar managers
Usually engineered to be non-correlated with the general markets
Cons
Investors don’t always know exactly what the fund owns
Investors often have limited access to funds
Can be expensive; the traditional hedge fund pricing model called for a 2% annual fee plus 20% of profits
Who it’s best for: Hedge funds are for sophisticated investors, due to their complex investment strategies. In most cases, you must be an accredited investor to buy into a hedge fund, which means you must have a minimum level of assets and income.
2. Precious Metals
Precious metals like gold and silver are more than just building blocks for jewelry. They are also investments in their own right.
Pros
Widely regarded as a hedge against inflation shocks
Not directly correlated with stock and bond markets
Cons
Don’t pay dividends or otherwise return capital
Long-term returns are weak in comparison with stock market
Can be expensive if you choose to store them, and commissions can be high
Who it’s best for: Precious metals are best for investors looking to hedge their positions in other investments, and have done their due diligence, particularly in a sharply rising inflationary period.
3. Futures
Futures are contracts in which buyers and sellers agree to exchange an asset in the future at a specified price. Futures are often used to hedge other investments if an investor anticipates a price drop in the future. They can also be used to speculate on future price movements.
Pros
Can hedge your investments
Leverage and margin requirements mean only having to put up a portion of your investment
Very liquid market
Cons
Speculative
Can lose more money than you initially invest
Who it’s best for: Futures can be used by both investors who want to hedge positions and financial advisors who want to make speculative gains.
4. Commodities
Commodities are products such as timber, corn, soybeans, oil and gas. They include a wide spectrum of raw materials and natural resources. You can buy the raw products themselves or funds that invest in commodities.
Pros
Can offer high returns
Good hedge against inflation
Diversified against other asset classes
Cons
Can be volatile
Carry numerous risks, including exposure to international currencies and turmoil
Assets under management can use speculative futures
Who it’s best for: Investors looking for diversification into nontraditional markets might be candidates for an investment in commodities.
5. Real Estate Investments
Real estate is land or property. From an investment perspective, you can either buy real estate outright or through various investment vehicles, such as real estate investment trusts.
Pros
Real estate can provide cash flow, through rental income or REITs
Real estate can perform well in rising inflationary periods
Cons
Individual real estate properties can go down in value
Real estate is generally more illiquid than other investments
Who it’s best for: Investors looking to diversify who believe in the long-term health of housing and real estate markets might be well-suited for these types of investments. Investors who don’t already own their own property might benefit even more from the diversification.
6. Collectibles
Collectibles are items like rare coins or artwork.
Pros
Can satisfy personal desires for collections
Typically uncorrelated with stock and bond markets
Cons
Can cost high commissions to purchase
The value of some collectibles, like coins, might be restricted to the intrinsic value of their metal
Can be illiquid
Might have higher tax rates upon sale than other capital gains
Who it’s best for: Rare coins and artwork appeal to collectors, who attach an emotional value to beautiful works of art. They also round out more traditional investment portfolios. Some collectibles fetch very high prices.
7. Crowdfunding Platforms
Crowdfunding platforms allow everyday investors to own a portion of a startup company. Whereas new companies used to raise money only from angel investors or venture capitalists, they can now draw from anyone.
Pros
Startups can have huge returns, especially if the company goes public in an IPO
Crowdfunding allows all investors access to startups
Most platforms have a menu of different investment options
Cons
Startup companies can be risky, and you can lose all your money
About half of all startups fail within the first four years
Who it’s best for: Crowdfunding platforms are a good option for investors looking for access to new companies that might have values or products in line with their own interests.
8. Venture Capital
A venture capital firm is something like an advanced version of a crowdfunding platform. Managers of a venture capital firm raise money and invest it into early-stage companies.
Pros
Professional managers have an edge when it comes to locating promising companies
Investments that pan out can generate high returns
Cons
Can be hard to access top-flight VC firms, which typically have a backlog of investors
Startup investments by nature are risky and volatile
Usually limited to investors with high net worth
Who it’s best for: Experienced investors that can handle the high-risk, high-reward nature of venture capital are most suitable for these types of investments.
9. Private Equity
Investing in private equity means buying shares of companies that do not trade on public markets, stock exchanges or are otherwise publicly traded. This can be an exciting way to participate in the growth of a new company.
Pros
Can offer the potential for high returns, especially if the company eventually goes public in an IPO
Private companies don’t have to disclose information to the public about their performance
Cons
Can carry a high risk
Can require multiyear investments
Who it’s best for: Private equity is suited to investors willing to take on additional risk in exchange for the potential of higher returns, and those who can afford to make multiyear commitments to an investment.
Final Take
Unlike ETFs or retail-oriented mutual funds, alternative investments have relatively high fees and minimum investments. They are also more illiquid and difficult to verify the financial data or value of than some securities but often have lower transaction costs.
Although stocks and bonds get most of the commentary from the financial news networks and newspapers, there’s a whole world of alternative investments out there to choose from. Most offer trading patterns that are non-correlated with more traditional markets, and all offer various pros and cons to different types of investors.
FAQ
Here are the answers to some of the most frequently asked questions regarding alternative investments.
What is an example of an alternative investment?
Here are some examples of alternative investments:
Hedge funds
Precious metals
Futures
Commodities
What is the best alternative investment?
Here are some of the best alternative investments to consider:
Real estate investments
Collectibles
Venture capital
Private equity
Is an ETF an alternative investment?
In a very general sense, an ETF can be considered an alternative investment as it is a similar investment strategy that mitigates risk such as with a hedge fund. So though not directly defined as an alternative investment, an ETF can operate in the same way when the returns through its diversified portfolio are not directly correlated to stocks and bonds.
Caitlyn Moorhead contributed to the reporting for this article.
This article originally appeared on GOBankingRates.com: What Are Alternative Investments?
