What Are Alternative Investments?

When you think about investing, the first thing that comes to mind is probably stocks and bonds. But these aren’t the only things you can invest in.

Alternative investments are non-traditional assets — anything from fine art to private equity to sports memorabilia. 

These assets grow in value just like traditional assets, but they can offer you higher returns, plus more diversification for your portfolio.

…

What Is an Alternative Investment?

An alternative investment is anything that falls outside of what might be considered a “normal” investment. 

Traditional assets that you’re probably more familiar with include stocks, bonds, and cash invested in products like certificates of deposit (CDs) or money market accounts.

Alternative assets can include things like: 

• Private equity (ownership in a company that isn’t publicly traded)
• Digital assets like crypto and NFTs
• Physical collectibles like art and trading cards 
• Commodities like gold or oil
• Real estate

READ MORE: How To Start Investing

Why Invest in Alternative Investments? 

Alternative investments are a way to (possibly) earn more returns than you would on traditional investments like stocks and bonds. I say “possibly” because no investment is guaranteed, but alternatives do often have higher returns in a shorter period of time.

Alternatives are also a way to diversify so that you get more variety in your investments. If the stock market drops, assets like art or gold are less likely to be affected.

READ MORE: Why Asset Allocation Is Essential for Investing

Why Alternative Investments Are Considered “Alternative”

Even though alternative investments can sometimes provide high returns, many investors don’t consider them.

That’s because alternative investments are more complex than traditional assets. They tend to be difficult to get and aren’t easy to convert into cash, and it’s often limited who can access them.

Outside of a Christie’s auction, there isn’t really a marketplace for the average investor to buy a rare Da Vinci painting, for example. That can make it challenging to add alternative assets to your portfolio.

Also, some alternative assets are limited to accredited investors. To be considered an accredited investor, you must meet one of the following:

• Earn $200,000 or more per year
• Have a net worth of $1 million or more
• Hold a Series 7, 65, or 82 license in good standing

Even if you meet these requirements you might lack the technical knowledge to know which alternative assets to invest in.

There are also a lot of fees for acquiring alternative assets and they have high upfront costs. For example, investing in collectibles or farmland may require you to make a full investment upfront.

Plus, there’s a lack of oversight for alternative assets, which means a bigger risk that you could lose your entire investment — with limited options to recover it. The collapse of crypto company FTX is a great example of how alternative investments can put you at greater risk. 

That said, alternative assets also make it possible to diversify your portfolio into markets that aren’t the stock market. Even if the economy tanks, an alternative asset can be a great way to protect your capital against a downturn.

READ MORE: What Is Risk Tolerance?

Types of Alternative Investments

There are many types of alternative investments you can add to your portfolio. Each one can offer different value depending on your personal financial goals — but each comes with unique risks, too.

Funds

Hedge funds, venture capital, and private equity are extensions of traditional investments, but outside of traditional markets. 

Private equity, for example, is a way to invest in private companies or startups that aren’t traded on a stock exchange. If a startup takes off, your investment can see rapid growth.

Or, if you want to be nimble with your investments, a hedge fund pools money from private investors and uses high-risk investment strategies for higher returns. Doing this can give you access to a wider variety of assets without putting all your eggs in one basket.

From there, you can even invest in secondary markets, like a fund of funds. This is similar to investing in an exchange-traded fund (ETF) or mutual fund — but instead of investing in a fund of stocks, a fund of fund invests in other hedge funds. 

Peer-to-peer lending

Lending is a way for institutional investors (like pensions and insurance companies) to earn a return. Peer-to-peer lending makes it possible for you as an individual to do the same thing. 

There are peer-to-peer lending platforms like LendingClub, which collect money from investors to fund loans for borrowers.

It’s similar to how a bond works: you earn interest from the borrower until the loan is repaid. After that, you can reinvest the principal in another loan or a different asset. 

Peer-to-peer lending does come with higher risks than bonds, especially if a borrower defaults on the loan and is unable to pay it back.

Real estate

Real estate typically includes owning physical properties, like rental properties, but it isn’t limited to that. It can also include securities like real estate investment trusts (REITs). 

A REIT is a company that owns and operates real estate that produces income. This includes commercial buildings like offices and shopping malls, rental properties like apartment buildings, and even hospitals.

Real estate investing used to require you to put a lot of money down, but there are now platforms such as Fundrise that make real estate investing far more accessible.

READ MORE: Fundrise Review: Invest in Real Estate for $10

Commodities

Raw goods like gold or coffee are another type of alternative investment. You can physically invest in these items and hold them for a period.

If you want to invest in commodities but don’t want to physically store your investments, you could opt to invest in futures contracts instead. These allow you to invest in something today and capture a profit if the market price increases later on.

Digital assets

Digital assets are investments like cryptocurrency and NFTs. 

Many of these are sold on exchanges where buyers and sellers speculate on the change in price, similar to foreign currency exchanges. These are highly volatile, so invest carefully.

Collectibles

Physical items like sports cards, memorabilia, fine wine, and art can also be considered alternative investments. 

Depending on their value, they can increase over time, providing a net gain when you decide to sell them.

Pros and Cons of Alternative Investments

Before adding alternative investments to your portfolio, there are a few things to consider.

Pros

• Diversification, especially in markets that aren’t correlated to the stock market
• Hedge against inflation
• Possibility for higher returns
• Long-term store of value

Cons

• Less regulatory oversight than traditional investments
• Higher risk
• Increased costs and fees to maintain
• Difficult to convert to cash
• Complex and may require specific knowledge
• Access may be limited to unaccredited investors
• No public marketplaces and limited historical data
• High initial investment might be required

How To Buy Alternative Investments

If you think alternative investments are right for you, there are a few ways to get started.

Digital assets, commodities, and real estate products like REITs are accessible on public marketplaces. In many cases, you can invest in these assets through an ETF using an existing brokerage account.

It’s also becoming easier to purchase collectibles. Things like sports cards can be acquired through online marketplaces like eBay, and platforms like Masterworks let you make fractional investments in pieces of art.

Crowdfunding is another way to access alternative investments, especially if you’re looking to invest in startups or real estate projects. Fundrise is a great example of this for private real estate development projects. 

These platforms can give you access to fast-growing investment opportunities without having to be an accredited investor. 

Best Alternative Investments

The best alternative investments for you depends on your financial goals and risk tolerance. 

Some assets, like residential real estate, have rapidly increased in value over the past few years, but commercial real estate has plummeted in some cities due to the rise of remote work.

To determine which alternative investment is right for you, figure out how much of your portfolio you want to allocate to alternatives. From there, look for opportunities to diversify your holdings. This can help you capture gains while simultaneously mitigating risks.

ETFs are one of the best ways to access alternative investments. ETFs are traded like stocks but bundle together a variety of assets all in one place. You can access them on public markets and trade them in your portfolio just like you would an individual stock.

The key is to not take on more risk than you’re willing to lose. Alternative investments can come with a lot more risk than traditional assets like bonds, especially because many platforms offering alternative investments aren’t regulated. 

Know your limits and build an investment strategy that works for you.

TL;DR

Alternative investments are assets that are outside of traditional investments, like stocks or bonds. Examples of alternative investments are real estate, private equity, hedge funds, collectibles, and crypto.

These investments can offer better returns than traditional investments, but they’re also more volatile. If you decide to invest in alternative assets, make sure to spread your investments out — don’t put all your money into just risky opportunities.

For more investing advice, check out these episodes of the Erika Taught Me podcast:

• Money & Investing Pitfalls to Avoid
• The Missing Piece in 99% of Financial Advice
• Investing Advice from the Most Powerful Woman on Wall Street

. . .