From working with clients, advisors are well aware that for many people, the first two things that come to mind when thinking of investing are stocks and bonds.
However, with the plethora of other options available outside of these more conventional assets, alternative investments may be an area you choose to explore together. To help your clients diversify your portfolio and make smarter financial decisions, here is a primer you may share with them on what they need to know about alternative investments.
What are Alternative Investments?
Alternative investments cover a broad range of assets that are “alternatives” to traditional options like stocks, bonds and cash. This can include real estate, hedge funds, gold, cryptocurrencies and even a collection of rare objects, such as priceless artwork – or even fine wines!
Historically, many types of alternative assets were limited to institutional investors accredited by the Securities and Exchange Commission (SEC) and high-net-worth individuals, according to Forbes. To be considered an accredited investor, you must either have had an annual income of at least $200,000 for the last two years, a net worth of over $1 million, or demonstrate “defined measures of professional knowledge, experience or certification” in the eyes of the SEC.
Today, however, there are plenty of alternative investment opportunities that anyone can take part in. For example, cryptocurrency and non-fungible tokens (NFTs) have become increasingly popular options, despite their volatility. Other assets like real estate or collectables have become commonplace as investors seek to diversify their financial portfolios. Many of these are packaged into exchange traded funds (ETFs), which provide a way to access alternatives in a generally low fee and liquid vehicle.
Do alternatives belong in your portfolio?
While some alternative assets might seem trivial, they can be critical in diversifying your portfolio and mitigating the volatility of traditional investments. This is because they behave differently than traditional investments and don’t necessarily correlate with the stock market or fluctuating share prices, Investopedia notes.
Potential benefits of Alternative Investing
As with any investment, alternative assets might not always be right for you, and you must only invest according to your risk tolerance. With that said, however, there are many potential benefits, including:
- Reduce Volatility: The stock market is notoriously unpredictable, even during times of economic growth. According to Aspen Funds, the value of private alternative assets is generally uncorrelated to the stock market and share price fluctuations because they are not publicly traded. By adding these assets to your portfolio, you can reduce your overall risk when the stock market drops significantly. While a long-term investor might not be concerned with short-term disruptions, some contend that this volatility can erase your compound interest.
- Increase Returns: Alternative assets offer a potential for higher returns compared to traditional investments in certain market cycles. However, there are many alternative assets that offer a higher rate of return. For instance, FarmTogether reports that farmland has demonstrated consistently strong returns in the last few decades–even beating out stocks, bonds and real estate.
- Hedge Against Inflation: Certain alternative assets rise in value with consumer costs. With inflation reaching the highest level seen since 1982, according to CNN, investing in these resistant alternatives can be highly beneficial. Assets that are effective in hedging inflation risk include: commodity futures such as oil, electricity, grain, beef and other goods; precious metals like gold; and real estate income.
Drawbacks of Alternative Investing
Despite the advantages to alternative investments, there are a few pitfalls that you should consider before making a decision.
- High Upfront Investment: Unfortunately, many alternative assets are not structured to be accessible to the average investor. Oftentimes, they require a high minimum investment along with additional fees that can be prohibitively expensive.
- Valuation Difficulties: Because alternative assets aren’t usually traded on the public market, getting an accurate valuation can be challenging. This leads to widely varying appraisals that can pose a great risk in some instances.
- Relatively Illiquid: Alternative investments tend to be fairly difficult to liquidate compared to conventional assets. On top of the subjectivity in value, this is due to the fact that they are not traded on a public market. As such, it is often up to the seller to find potential buyers.
- Lack of Regulation: Certain alternative investments are not regulated by the SEC and, therefore, have minimal public regulatory filings. As a result, investors have a much more difficult time gathering information on alternative assets.
- Potentially Greater Risks: While some alternatives may offer higher returns, they often come with increased risk. For example, certain cryptocurrencies can be subject to “pump and dump” schemes, according to CNET. This happens when the value of a coin is artificially inflated before the primary group of traders sells off their shares at a higher price, crashing the price for everyone else.
Get started with Alternative Investments
While it is clear that alternative assets can be highly beneficial to many investors, they also come with inherent risks that may need to be overcome. Getting started with alternative investments might seem overwhelming at first, but a financial advisor can guide you on your path to selecting the right alternative investments for your portfolio.
Baldridge, R. (2022, Feb. 23). What Are Alternative Investments? Forbes. https://www.forbes.com/advisor/investing/alternative-investments/
Connett, W. (2022, Jan. 23). The Pros and Cons of Alternative Investments. Investopedia, https://www.investopedia.com/articles/financial-advisors/092515/alternative-investments-look-pros-cons.asp
Fraser, B. 6 Benefits of Alternative Investments. Aspen Funds, https://aspenfunds.us/articles/benefits-of-investing-in-alternatives/
Why Invest in Farmland? FarmTogether, https://farmtogether.com/why-farmland
Tappe, A. (2022, March 10). Key inflation measure jumps to highest level since January, 1982. CNN, https://www.cnn.com/2022/03/10/economy/us-consumer-price-inflation-february/index.html
Gonzalez, O. (2021, Aug. 6). Cryptocurrency pump-and-dump schemes: What should you know about these scams? CNET, https://www.cnet.com/personal-finance/crypto/cryptocurrency-pump-and-dump-schemes-what-you-should-know-about-these-scams/