You’ve successfully built a solid investment portfolio with traditional assets like stocks and bonds, but lately you’ve been hearing more about alternative investments. Maybe you’ve considered branching out into real estate or clocked a recent surge in crypto. You’ve probably heard about some investors turning toward commodities like gold. 

Would a more diverse portfolio benefit your goals? There are tons of questions and concerns around nontraditional assets like these, and it can be stressful trying to get started. There’s often greater risk in these alternative markets, especially for investors who are unfamiliar with their specific mechanisms. The factors you look at to make good investment decisions are usually pretty different from the ones you’d consider with more traditional investments.

Understanding alternative investments and the part they play in diversifying your portfolio can help expand your options. Traditional assets form the foundation of a strong portfolio, while alternative investments can broaden your financial horizons.

Getting Started with Alternative Investments

What are Alternative Investments?
  • Assets other than traditional stocks, bonds, and cash
  • Require specialized knowledge and expertise
  • Include crypto, private equity, real estate, hedge funds, commodities, and more

 

What are the pros and cons of alternative investments?
  • Pros
    • Portfolio diversification beyond traditional markets
    • Potential for higher returns
    • Protection against inflation
  • Risks:
    • Limited liquidity
    • High minimum investment requirements
    • Complex fee structures
    • Greater risk of principal investment
Why should you consider alternative investments?
  • Adds valuable diversity to your investment strategy
  • Provides access to unique market opportunities
  • Helps protect wealth in volatile economic conditions

 

What Are Alternative Investments?

Alternative investments are any investment that falls outside the realm of traditional stocks, bonds, and cash. A traditional investment portfolio is like a well-built house that provides shelter and security. Alternative investments are like added rooms or features that can potentially make your home more valuable.

These investments typically require more specialized knowledge and often come with different rules and structures than traditional investments. If you are considering alternative investing, it’s important to work with a specialist who can help make the most of your portfolio. 

Types of Alternative Investments

Private Equity

Private equity involves investing directly into private companies or buying out public companies to take them private. These investments often focus on companies that either need significant improvements or are in high-growth stages (such as a start-up), but aren’t ready for public markets. Think of it as being an early investor in a company before it becomes a household name.

Hedge Funds

Hedge funds are actively managed investment pools that use sophisticated strategies to generate returns in various market conditions. These exclusive funds typically employ strategies like long-short equity, global macro trading, or event-driven investing. Due to their complexity, they’re usually only available to institutional investors and high-net-worth individuals.

Real Estate

Real estate investments can include commercial properties, apartment buildings, real estate investment trusts (REITs), or even farms and timberland. These investments often provide two potential benefits: ongoing income through rent and long-term appreciation. Success in real estate investing requires expert valuation skills and market knowledge, as property values can fluctuate significantly based on location, economic conditions, and property maintenance.

Commodities

Commodities include physical goods like precious metals, agricultural products, and energy resources. Their value is primarily based on supply and demand dynamics in global markets, making them move differently than traditional financial assets. This independence from financial markets often makes commodities an effective inflation hedge.

Infrastructure

Infrastructure investments include assets like toll roads, airports, utilities, and telecommunications networks. These investments typically provide steady, long-term income streams and often have built-in inflation protection through regulated price increases.

Collectibles

Fine art, rare wines, vintage cars, and sports memorabilia are just a few examples of the collectibles category. Collectibles can serve as legitimate investments, even though they are often driven by an individual’s passion for the items. 

Collectibles also carry unique risks when it comes to investing: authenticity concerns, storage requirements, insurance needs, and potentially high transaction costs when buying or selling. Their value can also be highly subjective and influenced by changing tastes and trends.

Cryptocurrency

Digital currencies represent a new frontier in alternative investments. Cryptocurrencies can be highly volatile, but they also have unique benefits like decentralization and potential protection against traditional currency devaluation. They also operate on blockchain technology which can provide transparency and security features that you won’t find in traditional currencies.

Pros & Cons of Alternative Investments

Alternative investments can add valuable diversity to your portfolio, but like all investments, there are benefits and risks to consider. It’s important to understand how they might work for – or against – your financial goals.

Benefits of Alternative Investments

Diversification

Alternative investments typically move independently from traditional markets. This type of portfolio diversification can help protect your wealth during market downturns.

Potential for Higher Returns

With some alternative investments, you’ll be able to access unique opportunities that aren’t available through traditional investments. This can potentially lead to higher returns.

Less Volatile 

Alternative investments can have more stable valuations since they’re typically based on long-term fundamentals rather than day-to-day market swings.

Protection Against Inflation 

Many alternative assets have intrinsic value and built-in inflation adjustments. As part of a balanced portfolio, this can help maintain your purchasing power over time.

Alternative Investment Risks

More Complex 

Alternative investments can be more challenging to evaluate than traditional ones. They often require specialized knowledge and thorough due diligence to become sustainably profitable.

Less Liquidity 

Unlike stocks or bonds, alternative investments can’t be quickly converted to cash. Some may even require holding periods of several years.

High Investment Minimums 

Most alternative investments require significant capital commitments up-front, sometimes with minimums in the six or seven figures.

High Fees & Maintenance Costs

Alternative investments typically involve multiple layers of fees which can significantly impact your overall returns. These can include management and performance fees, as well as maintenance and upkeep costs associated with physical assets like buildings and infrastructure.

Additional Key Considerations

Regulations

Alternative investments often have very different regulations than traditional investments. This regulatory flexibility can create profitable opportunities, but it also means you’ll need to be particularly thorough with your research and documentation. 

Before committing capital, you should thoroughly understand the investment’s structure, review all offering documents carefully, and seek professional guidance to evaluate complex terms or unusual provisions. Less regulatory oversight means more responsibility falls on you as an investor to understand what you’re getting into.

Taxes

Alternative investments each come with their own distinct tax rules, and these rules can change frequently as regulations are updated. This is especially true for newer investment classes that are still growing in popularity, such as cryptocurrency.

Understanding the tax implications of any investment should be a standard step in your decision-making process. What seems like an attractive return can look quite different once you factor in the tax exposure. Be sure to discuss potential tax consequences with your financial advisor before adding alternative investments to your portfolio.

How to Invest in Alternative Investments

The steps you’ll take to invest in alternative assets can vary significantly depending on which type of investment interests you. Some alternatives are readily accessible to most investors, while others have strict requirements and limitations.

For example, cryptocurrency investments can be obtained through mainstream crypto exchanges or traditional brokers with relatively small amounts of capital. In contrast, hedge funds typically require accredited investor status and may have net worth requirements of $10 million or more.

Why Invest in Alternative Investments?

Alternative investments can provide valuable diversification to your portfolio. The assets and strategies of alternative investments behave differently from traditional stocks and bonds. This independence from traditional market movements can help protect your wealth during volatile economic conditions.

Access to more diverse markets and strategies offer opportunities to tap into potential returns that might be missed in traditional markets.

Final Thoughts

While alternative investments can be valuable tools in a well-designed investment strategy, they often come with greater risks, either because the markets themselves are more volatile or the investment instruments themselves require specific knowledge or expertise on the part of the investor. 

Often, there’s a high barrier to entry in getting started investing in these alternative assets. This is why working with a financial planner with expertise in these markets should be your first step in branching out.

At SK Wealth, our financial advisors have been helping clients navigate complex investment decisions for 25 years. Through our Integrated Financial Advantage™ process, we create personalized recommendations that align with your goals and risk tolerance, helping you make confident decisions about incorporating alternative investments into your portfolio. We understand that each situation is unique and requires careful consideration of all available options to create the most effective investment strategy for your family’s future.

Click here to find out more about SK Wealth’s specialized financial planning and investment management services.

Matthew Neyland

Author Matthew Neyland

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