What Are Alternative Investments?

March 18, 2021

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What we’ll cover:

An alternative investment is a type of financial asset that falls outside of the traditional investment categories of stocks, bonds and cash
Private equity, hedge funds, real estate, commodities and collectives are five common types of alternative investments
Alternative investments are typically considered illiquid assets and are often unregulated by the SEC
Alternative investments offer the opportunity for some investors to further diversify their portfolios, try out new investment markets and potentially score high returns

When you think of investing, stocks, bonds and exchange-traded funds (ETFs) are some of the traditional types of assets that come to mind. That’s because they’re usually the bread and butter of a basic, diversified portfolio.

But there’s another world out there when it comes to investing.

Beyond the traditional assets that we often read about lies the world of alternative investments. (Cue the grunge music.)

As the name implies, an alternative investment is a type of financial asset that falls outside of the traditional investment categories of stocks, bonds and cash. Private equity, hedge funds and collectibles (you know, the finer things in life such as art and wine) are just a few common examples of alternative investments.

Despite their level of risk and complexity, alternative investments can be appealing to some investors.

Because they’re unconventional (and often high-risk), alternative investments are typically held by institutional investors and high-net-worth individuals. But that doesn’t mean they’re completely out of reach for regular individual investors.

Access to these investments is gradually expanding. And interest among mainstream investors is on the rise. That’s because for some investors, alternative investments provide the potential opportunity to further diversify their portfolios, boost returns and look beyond the stock markets to build wealth.

In this article, we’ll go over the basics of alternative investments and run through some common examples you may see as you explore this nontraditional side of investing.

How alternative investments work

Sometimes you’ll see alternative investments referred to simply as “alternatives” or “alt investments.” (See, we’re hip.)

Now, the list of alternatives is long and varied. And while we can’t cover them all here, we can start with a quick look at the five common types of alternative investments.

Private equity (PE) is a capital investment in private companies (read: nonpublicly traded) to help them grow their business. Because the minimum investment requirements can be quite high (we’re talking about millions of dollars), PE investments are generally only available to high-net-worth or accredited investors.
Hedge funds are investment funds that use complex investment strategies to generate high returns. Like PE, hedge funds are typically limited to high-net-worth investors as well as institutional investors.
Real estate includes properties like residential apartments, office buildings and even timberland and farmland. Real estate investment trusts or REITs are also part of this category.
Commodities include assets like precious metals, oil, natural gas and agricultural products. Investing in commodities is often considered as a way to hedge against inflation.
Collectibles are any rare, specialty items whose value might grow over time. This category includes the fun stuff like artwork, vintage wines, classic cars, custom watches, baseball cards, toys and comic books. The list goes on, but you get the idea.

You can see just how broad the alternative investments category can be. One important thing to keep in mind is that each type of alternative comes with its own level of risk and complexity – as well as investment considerations (how they’re traded and valued, their accessibility, liquidity, fees, costs, etc.).

So for example, the approach you might take to investing in fine art will likely be different from how you invest in, say, a hedge fund. Whatever asset you may be considering, know that investing in alternatives generally requires a lot of research and due diligence. In other words, expect to do some homework.

All that being said, alternative investments do share a few general characteristics.

They’re typically considered illiquid assets.
They’re often unregulated by the Securities and Exchange Commission (SEC).
They typically have a low correlation to standard asset classes. This is a nerdy way of saying they don’t usually move in the same direction as traditional assets in the stock or bond markets.
They can be difficult to value. Depending on the asset, information about its pricing and performance might be hard to come by.

Let’s use a piece of artwork as an example. It’s relatively illiquid, compared to a traditional asset like stocks, because it may take some time for you to find a buyer. It can also be difficult to judge an artwork’s value. To find out, you usually have to take the piece to appraisers. And you’ll probably run into some disagreements there. After all, what is…art? Compare this to a stock, whose price you can look up online almost anytime.

Why people invest in alternative investments

At this point, you may be wondering why people bother with alternative investments. After all, they’re relatively illiquid, largely unregulated and complex – or in fewer words, high-risk. (And they sound like a lot of work!)

Some people see alternative investments as a way to hedge against inflation and build wealth outside of the traditional financial markets.

The opportunity for diversification and higher returns is also appealing to some investors.

Diversification. Alternatives give investors an opportunity to diversify their holdings – outside of the stock and bond markets. Remember when we mentioned that alternatives typically have a low correlation to standard asset classes? This is why some investors see alternatives as a potential diversification tool that can help reduce their exposure to the stock market.
Potential high returns. Because alternatives can give investors access to a broader set of investments and strategies, there is a potential to earn higher returns (compared to investing in traditional assets). Yes, alternatives tend to be high-risk, but there’s also the possible opportunity for high rewards.

Who can invest in alternative investments

Because of the level of risk and complexity, for a long time, access to alternative investments was limited to institutional investors and accredited investors. In other words, investors with a lot of money. To give you an idea, an accredited investor is someone who earned more than $200,000 in annual income for the past two years or has a net worth of more than $1 million.

If you’re thinking about making a move to alternative investments, it’s a good idea to talk to a financial advisor before getting started.

But in recent years, growing interest in alternative investments has made it possible for regular individual investors to invest in certain alternatives.

For example, there are alternative mutual funds (aka “alt funds” or “liquid alts”) that invest in non-traditional assets like real estate and commodities. While many types of alternative assets aren’t regulated, alt funds are publicly traded and registered with the SEC.

The bottom line

The world of alternative investment is a big one. It comes with a long and varied list of non-traditional assets and investment strategies to consider. Despite their level of risk and complexity, alternative investments can be appealing, as they offer the opportunity for some investors to further diversify their portfolios, try out new investment markets and potentially score high returns.

But due to their high-risk profile and generally high investment costs, investing in alternatives isn’t for everyone. So if you’re thinking about making a move, it’s a good idea to talk to a financial advisor before getting started.

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