What Are Alternative Investments? [The Simple Investor Guide]

As you begin growing your net worth and investing money, you might be wondering how to diversify beyond the stock market

What Are Alternative Investments? Naturally, your investment portfolio should have various assets that can help amplify your wealth. But also ensure you are not putting all your eggs in one basket (I know, I know lame cliche statement). 

One area that you should consider when investing is assets that fall into a category called, “alternative investments.” 

It’s a pretty diverse group of investment options and not every alternative investment type is right for you. But there is much to consider. 

Below is everything you need to know about alternative investing. 

What Is An Alternative Investment? 

Before anything, you need to know what an alternative investment is and more about it. So to begin, let’s start with a simple definition to get on the same page.

An alternative investment is any financial asset that does not fall into the standard or traditional investment categories, which include stocks, bonds, and cash. 

Traditionally, most alternative investment assets are held by a financial company (not a brokerage account) or by accredited, high net worth individuals. 

The reason alternative investments were generally for high net worth investors, is because these are more complicated and have an increase of risk.

However, alternative investments are more readily available to the non-accredited crowd as well these days. 

Thanks to SEC laws and changes around crowdfunding, there are options to invest in different assets that are not publicly traded or follow the stock market trends too.  

This gives everyone equal opportunity to diversify their portfolios and experiment in other investment types that were typically only options for accredited investors. 

Lastly, there are also some alternative mutual funds and exchange-traded funds that are publicly traded too. 

Pros and Cons of Alternative Investments

As with any investment, there are always some advantages and disadvantages.

Ultimately, it’s your personal finance goals, interests, knowledge, and risk tolerance that will help determine what you will invest in. 

Now that you know what alternative investments are and the differences between them and traditional assets, let’s get into the pros and cons. 

Pros of Alternative Investments

One immediate advantage of alternative investments is that it typically does not correlate to the stock market.

Meaning, the ups and downs of the stock market will typically not reflect in your alternative investments and can help balance your portfolio a bit.

Now, if the economy is in serious turmoil then your alternative investments (pending which ones you are invested in) can still feel some pain.

But, generally you are building a portfolio that works well, when another area may be facing volatility. 

The other attractive reason to consider alternative investments is the potential for higher returns than your traditional investments.

Like anything, there is no guarantee and you still are risking money, but the payoff can be much larger. 

While those are two of the strongest pros, there are a few additional positives as well:

  • More portfolio diversification
  • Helping hedge against inflation
  • Oher tax benefits not available in traditional investments

Cons of Alternative Investments

Okay, before you see dollar signs everywhere let me bring you back down to reality here. 

While there are pros of alternative investments, there is still some significant risk and downside you have to be prepared for as well. 

First, alternative investments are generally more complex to understand and involve more knowledge to really succeed. 

And along with that, these assets can be more volatile (even though they do not typically follow stock market trends).

They are a bit more unpredictable and also illiquid, meaning it’s not easy to exit out. Generally, these are long-term investments before you see a significant return or are able to sell off your assets. 

One counter to these challenges is the crowdfunding market, which takes the pain out of much of the understanding and makes it easier for investors to get started.  

For example, there are real estate crowdfunding platforms, better ways to invest in art, farmland, commodities, etc. 

But crowdfunding and these companies are also still a newish model that comes with risks and fees as well. However, it is a step in the right direction as the legit ones work with the SEC and pushing towards lowering fees. 

However, besides the above, here are some general cons of alternative investments:

  • Difficult to value what somethings are worth
  • Typically unregulated (if outside crowdfunding)
  • High-risk investments with no guarantee
  • Higher minimum investments required (If outside crowdfunding) 

What Are The Main Types of Alternative Investments?

So you know that alternative investments are not stocks, bonds, are cash — so what are they? 

Well there is a pretty big list of options, but I narrowed it down to the main types I think are worth your time and potentially exploring. 

Real Estate

The most common alternative investment is investing in physical properties. However, there is so much to cover, I’m not going to spend too much time here.

However, what you should know is that real estate is a great wealth building investment and part of the “alternative investing” crowd. Many people have built their wealth by buying and flipping properties, owning rental properties, or using AirBnb. 

But, with SEC regulations changing and many new ways to invest, real estate is becoming easier to get started with and requires less capital to get started. 

Land

One subcategory of real estate that many consider investing money into is land. Typically for wealthy individuals, there is an array of land options to consider:

  • Residential development land
  • Commercial development land
  • Farmland
  • Vineyards
  • Timberland
  • Mineral production land
  • Orchards
  • Recreational land

But like general real estate, there are some crowdfunding platforms that give you easier access to investing in various land types. 

Fine Art

Investing in art has been around for awhile, but can be pretty difficult to get involved with.

Originally, you would either need millions to directly purchase well-known art, take a risk on brand new artists and hope they gain traction, or be an accredited investor and pool money directly into various art funds. 

But there are more options once again, thanks to the crowdfunding market where non-accredited investors can have access to well-known fine art. 

So why should you consider investing in art

Well, art was the top performing asset class of 2018, beating gold, real estate, classic cars, and the S&P 500 according to the Wall Street Journal. 

There is certainly risk involved as well, but another alternative investment that might be intriguing for your portfolio. 

Commodities

A commodity is considered an economic good or service. So when it comes to investing in commodities, you’ll be looking at popular assets like precious metals such as gold, silver, platinum. 

Yet, it goes beyond metals too. Some other commodities include crude oil, natural gas, ethanol, corn, soybeans, wheat, cocoa, coffee, sugar, etc.

Many of these items can be bought in ETFs or mutual funds in your investing platform or you can physically buy and invest in precious metals like gold.

The Motley Fool has some good info about investing in commodities if you are looking to explore further.

Riskier Alternative Investment Types

Cryptocurrency

We certainly cannot talk about alternative investments and not include the cryptocurrency hype of the last few years. I personally never jumped into these digital coins, but that doesn’t mean there is no value. 

Bitcoin, Ripple, Liteocoin, Ethereum, etc. are all digital currencies that have been highly talked about in the media headlines in the last few years. Although some of the hype has slowed down, it’s still alive and well. 

The challenge with cryptocurrency is there are no major regulations currently and the volatility can be pretty wild. 

However, the idea beyond these digital coins and technology behind it is here to stay. If you do go this route, invest with caution.

Hedge Funds

Another relatively risky alternative investment is being a part of a hedge fund. 

A hedge fund is an investment fund that essentially collects capital from accredited investors or institutional investors and invests in a variety of assets.  

What can a hedge fund invest in? 

Well, pretty much anything like land, real estate, stocks, derivatives, and currencies. And these investments are often filled with more complicated portfolio options so they are managed by a investment management firm.

Hedge funds are only slightly regulated and face less regulation than mutual funds and other investments. The downside here is that hedge fund opportunities are only for accredited investors, so you’ll need a high net worth to get involved. 

Additionally, these investments in hedge funds are illiquid and generally money is tied up for a minimum of one year. Typically there are withdrawals periods, where in certain intervals you can actually get your money out. 

Private Equity

Another high risk, yet high reward alternative investment is private equity. In simple terms,  private equity is composed of funds and investors that will directly invest in private companies that are not listed on public markets, IE stock market.

Accredited investors or institutions provide the capital for private equity, which the company will use to either expand the workforce, acquire other businesses,  have more capital for other business needs, etc. 

The risk is that private equity usually requires a large sum of investment money, longer holding periods of funds, and no guarantee of reward. 

The goal is that the company may be listed on the stock exchanges, providing a large return on investment. Or the company is sold to a much larger public company. 

Final Thoughts

As you expand your investing knowledge and learn how to better diversify, you’ll realize that alternative investments can be a great addition to your portfolio.

The challenge is, alternative investments can be volatile and be a greater risk than say the stock market. 

But, this is why you should only dedicate a small percentage of your money to these investments.

Typically less than 15%, with an ideal range in the 5-10% range. This allows you to get diversified exposure to other markets, but lowers the risk of catastrophic losses. 

Start off small to limit your risks and diversify your alternative investments just like you would with stocks and bonds. 

Are Alternative Investments Safe?

Some alternative investments are quite safe and have relative risks to traditional investing (stocks and bonds). However, others offer a higher degree with risk which means you need to understand what you can afford to potentially lose if an investment went south.

Key Takeaways:

  • Alternative investments are assets you invest in outside of stocks and bonds
  • Adding alternative investments helps diversify your portfolio even further
  • Typically, alternative investments do no follow the stock market movements
  • Investing in alternative assets has become easier for the non-accredited crowd with crowdfunding. 
  • These investments are considered high risk, but also come with potential high rewards
  • Very illiquid, meaning your money is tied up for longer. Typically you’ll see investing horizons of 5+ years. 
  • Some of the riskier investments will require you to be an accredited investor, which the majority of people are not.