Alternative Investments: A Look at Different Ways to Invest
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When it comes to investing, everyone’s familiar with stocks and bonds but there is a whole universe outside of these traditional asset classes. Known as alternative assets, they include hedge funds, rare collectibles, private equity, venture capital, and many more. They allow investors to diversify their holdings and enjoy gains that are less correlated with the stock market.
Related: Assets That Appreciate in Value
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What is an alternative investment?
An alternative investment is a financial asset that does not fall into the traditional investment categories of stocks, mutual funds, and bonds. It includes investments like venture capital, private equity, managed funds, hedge funds, and art. Real estate is also a part of alternative investment. They are also known as “alts” and aren’t traded publicly on the equity markets like NASDAQ or NYSE. But they are invested through exclusive ways like wealth management funds or hedge funds and ideally for individuals with high net worth.
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Who is eligible to buy alternative investments?
Investing in most types of alternative investments has been limited to the high net worth individuals known as accredited investors. Since most alternative investments are not traded on the market, they remain unregulated by the SEC. An accredited investor will require an annual income of $200,000 and an income of $300,000 for a couple for the last two years.
How to buy alternative investments?
Investing in alternative assets comes with bigger challenges than investing in the traditional asset classes. They do offer portfolio diversification and higher returns but do not come without risks. If you want to invest in alternative assets, it is important to perform due diligence. For those who aren’t accredited investors, access to alternative assets could be limited but there are many mutual funds and exchange-traded funds that offer an opportunity to buy alternative assets. That said, there are a few platforms like Fundrise and Vinovest that have made investing in alternative assets easier. Depending on the type of investment you want to make, you can choose a platform for the same. If you are a beginner, it is advisable to seek help from a financial advisor.
Types of alternative investments
Private Equity Funds
The private equity funds are pooled investment vehicles and their purpose is to acquire controlling stakes in the public or private companies. The fund will take an active role in managing its portfolio companies while providing financial and intellectual capital. If the fund acquires a stake in a company, its goal will be restructuring the firm and then providing capital to help achieve growth. The fund will turn a profit when it liquidates its stake by taking the company public through an initial public offering (IPO) or by selling it to another company.
There is less competition to buy equity from a private company as compared to a public company and private companies are comparatively smaller which allows investors to get more involved in the business. That said, it also offers an opportunity to invest early on, thus making it easier to enjoy greater returns in the long run when the valuation improves and there is a chance of a buyout.
Hedge funds
Slightly similar to private equity funds, hedge funds are private, pooled investment funds but their goal is different. The funds seek high returns through risky investment strategies and they can put the participants’ money in anything. The investments can range from derivatives to publicly-traded securities and even startups. The funds are organized as private investment partnerships where the partner manages an investment portfolio and makes all the decisions.
It is one of the more sophisticated investments. Accredited investors pool the money and give it to the hedge fund. This fund then uses various strategies to generate returns for the investors. The fund is managed by professionals who have an understanding of the investment and know what will succeed. But there is a lack of transparency which is one thing you must consider before investing. Always read the fine print and then make a decision.
Real estate
A very accessible alternative investment, real estate investment remains one of the top choices for many investors. Most people are already invested in this asset class by purchasing their homes. Real estate investment can generate a solid return in the long term if you sell the property. But you can also enjoy consistent cash flow by renting out the apartment buildings or the shopping centers. The reason real estate is one of the most appealing and popular alternative investments is that it appreciates with time. Depending on the type of property you invest in, you will see the appreciation. If you invest in a residential property, its value will grow when the neighborhood grows and flourishes.
This is why it is important to understand the different types of properties and then think of investing. Real estate is also considered an inflation hedge. It will reduce the impact of inflation on your portfolio while offering an opportunity for diversity. Real estate also comes with tax benefits and is a viable strategy for generating cash flow.
However, if you do not have the funds to invest in a property, you can consider investing through real estate investment trusts (REITs). The trust through companies like Fundrise will pool the money from investors and invest in commercial properties. You will earn a dividend on your investment without having to worry about managing the property.
Reasons To Use Stash For Investing
- Get $5 to Make Your First Investment
- Invest in Stocks and ETFs with $1 or Less
- Receive Your Paycheck up to 2 Days Faster
- No Overdraft Fees or Minimum Balances
Venture capital
Venture capital is gaining in popularity today as they provide funds to promising startups in exchange for equity. Just like the private equity firms, there is an investor who takes an active role in the management and makes the right decisions. But venture capital investors tend to stay in investment for a longer period than the private equity funds. They usually exit after an IPO, merger, or acquisition and continue to monitor the progress until exit. The difference between venture capital and private equity is that venture capitalists are here for the long term while investors in private equity tend to buy and sell quickly.
Fund of funds
A fund of funds works just like a hedge fund but it invests in other hedge funds, mutual funds, and private equity funds instead of the traditional stocks and bonds. It will give you access to funds you wouldn’t otherwise have because of the high minimum investment amount. When you invest in a fund of funds, you let the team make the right decisions for you and the trick is to find the right fund managers for the task. Remember, do not base your decision on their past performance.
Natural resources
There are many natural resources including commodities and forests to invest in. Large companies invest in natural resources by purchasing barrels of oil or iron ore and use it as a raw material to make other products. But regular investors can also invest in commodities through derivatives like futures and options.
Private mortgages
Those looking for a low-risk option with attractive yields should consider investing in private mortgages. It is a loan provided to a real estate owner and there is a contract ranging from 1 to 5 years. It is a low-risk alternative investment since the loan is made at 60 to 70% of the market value of the property and it is backed by real estate, hence, even if the borrower defaults on the loan, the risk will be low. But it is still important to vet the investment and read the fine print before signing the documents.
Related: Best Crowdfunding Investing Apps
Artwork and collectibles
You can invest in artwork and collectibles if you have the knowledge and patience. It is all about predicting how and when the investment will grow in value. It is hard to judge the appeal and demand of the artwork a few years down the line and if you do not know what you’re doing, it could be a shot in the dark. Masterworks is an entryway to investing in art by offering fractional opportunities to own art. Further, artwork and collectibles like wine can be very illiquid and there are chances that the investment could lose value in the long term. Hence, make sure whatever you are buying is something you will always cherish.
Commodities
You can invest in intangible assets that are used to create products for us. It includes precious metals, livestock, crops, and more. Besides that, you can also invest in soft commodities like coffee, cotton, or sugarcane. The commodities can be directly bought and sold on the stock market or through futures and options. It is an investment that benefits from inflation.
Cryptocurrency
Having gained massive popularity recently, cryptocurrency is digital money that is enabled by blockchain technology. Investing in cryptocurrency is simple but it comes with high risk. There is high volatility in the price of cryptocurrency which adds to the risk. That said, it also has a security risk for your holdings since the digital wallet where you store them is vulnerable to hacking. However, the value of cryptocurrency will continue to increase in the coming years, and transacting using crypto could become commonplace.
Related: How to Invest in Crypto
Structured products
Structured products mean investment in the fixed income markets. The ones that will pay dividends like bonds or the securities that derive their value from an underlying group of assets like bonds or stocks. They can be risky and slightly complex to understand. They are usually created by investment banks and offered to retail investors, institutional investors, or hedge funds. Similarly, structured notes are securities that combine bonds and other additional investments. They carry the benefits of investment assets and debt assets. But they are derivatives and can be risky for an average investor.
Pros and cons
Pros
- Diversification. Adding alternative assets to the portfolio will help achieve diversification.
- Low volatility. The alternative investment will not be exposed to the broad market and it will have a lower impact on market volatility.
- Inflation hedge. Investment in assets like gold, real estate, or silver will work as a hedge against inflation.
- Low correlation. A huge benefit of investing in alternative assets is its minimal correlation with the traditional asset classes. So, when the stock market is under pressure, your investment in alternative assets could be doing very well.
- Potential for higher returns. The investment comes at higher risk which means it will also offer the potential for higher returns.
Cons
- No regulation. Alternative assets do not have the same regulations as traditional assets. They are not registered with the SEC and are not regulated. This also means that there is a lack of transparency due to the absence of public regulatory filings.
- Hard to value. Since there is no market price, it can become hard to determine the value of alternative assets like art or collectibles.
- Low liquidity. The assets are not publicly traded and could be difficult to buy or sell in the public markets. Some investments also have a lockup period when redemption is not possible which makes them highly illiquid.
- High risk. There is a potential for high returns but it comes with high risk.
- High minimum investment. Alternative investments are not designed keeping the average investors in mind and the minimum investment requirement is significantly high, making it out of reach for many.
Reasons To Use Stash For Investing
- Get $5 to Make Your First Investment
- Invest in Stocks and ETFs with $1 or Less
- Receive Your Paycheck up to 2 Days Faster
- No Overdraft Fees or Minimum Balances
The bottom line
This is by no means an exhaustive list of alternative investments but it is a list of the most well-known options. It is advisable to research your options before making a decision. Generating high returns comes with high risk and the same is the case with alternative investments. No matter the type of investment you choose, it is important to perform due diligence to find the one that is an ideal fit. Due to the lack of public information, it can become harder to find the right investment for your portfolio.
But the truth is, there will always be some amount of risk involved in any investment you make. Hence, consider your risk appetite and form the investment strategy accordingly. Remember, diversification is the key to generating wealth and there are ample investment opportunities out there for you to explore.
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Writer
Vandita Jadeja is a financial writer and editorial assistant at Joywallet. She loves to read and write about money and brings 7 years of experience from the financial industry. She loves coffee, mountains and sunsets.
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