As an investor, you may have heard the term “alternative investment” frequently over the past few years. Alternatives to traditional stocks, bonds and mutual funds have become an increasingly important part of the global investment landscape. Between 2013 and 2020, the market for alternatives grew from $7.9T to $10T. By 2023, that number is expected to reach a staggering $14 trillion. The total value of the global equity market, for comparison, reached $116T in 2021.
While these non-traditional investments are experiencing a surge in popularity, many investors are still confused about what they are and how they work. Here are seven things you should know about alternative investments to decide if they are right for your portfolio.
Alternative Investments Can Take Many Different Forms
As the name suggests, an alternative investment can be virtually anything other than a stock, bond or mutual fund. This can include many assets that are thought of as very traditional investments, such as commodities and real estate. Below, you’ll find a list of alternative investments to show just how broad this category of assets can be:
- Fine art
- Private equity
- Peer-to-peer loans
- Wines and spirits
- Jewelry and antiques
- Fractional real estate shares
- Intellectual property
- Mineral royalties
- Tax liens
Needless to say, this list of alternative investments is far from exhaustive. Practically any asset that appreciates, stores value or produces some form of cash flow can be considered an alternative investment.
Non-traditional investment opportunities have expanded considerably in recent years as a result of technological advances. The ability to buy and sell these assets digitally has made them far more accessible and allowed many more companies to offer them.
Fractional real estate shares are one good example of this digital advantage. By dividing properties up into smaller shares and allowing investors to purchase them, fractional shares let you access the benefits of real estate investment without the large up-front cost. This kind of digital approach to offering non-traditional investments has given retail investors far more opportunities today than they have ever enjoyed in the past.
They Aren’t Publicly Traded
One of the defining characteristics of an alternative investment is the fact that it does not trade on a public exchange. Unlike stocks and bonds, alternative investments are mostly bought and sold by private companies and individuals. This allows non-traditional investments to trade outside of ordinary market hours. As long as a buyer and a seller can agree on a price, the transaction can be conducted at any time.
One of the downsides that this trading model introduces is a lack of liquidity. Without public exchanges, it’s much harder to convert alternative assets into cash quickly. Some alternative investments address this problem by providing reliable cash flow. Fractional real estate shares that distribute monthly rental income, for instance, offer a reliable stream of cash for investors.
Alternative Investments Are Less Regulated Than Stocks and Bonds
Generally speaking, alternative investments aren’t subject to the same levels of regulation that apply to stocks, bonds and other traditional investments. While lower regulatory thresholds allow for more innovation, they also introduce an added layer of risk. Before putting your money into a non-traditional investment, be sure to read all filings or statements related to it. In the absence of ordinary regulation, it’s extremely important for investors to fully understand the nature of an asset before buying it.
With that said, the lower levels of regulation associated with alternative investments can also be positive for investors. Companies that offer non-traditional investments are freer to innovate and use technology to serve their customers’ needs. For instance, some alternative investment platforms leverage AI technology to select favorable assets. This kind of technology often helps investors realize higher returns while managing risk.
They May Produce Higher Returns Than the Stock Market
As you might expect, the added risk of regulation and lower liquidity carried by non-traditional investments require them to produce higher returns for investors. As an example, investing in fine wine historically provides returns of 10-15% annually. The average return rate of the S&P 500 since expanding to 500 stocks in 1957, by contrast, is 10.67%. In other words, the average return of America’s most prominent stock index is toward the lower end of the historic return range on fine wine.
Similarly high returns can be seen in other alternative investments. Peer-to-peer loans can produce returns of 15%+. Farmland returns an average of 11%. Cryptocurrencies, by far the most volatile non-traditional investment, have been known to produce returns of over 1,000% in a year. While there are also safer, lower-yielding alternatives, the potential for outsized returns is one of the major appeals of investing outside of stocks and bonds.
Alternative Investments May Not Move With the Overall Market
Another advantage of alternative investments is that they usually aren’t highly correlated to the broader stock market. As a result, they can be very useful for diversifying your portfolio and hedging against market downturns. This is especially true of tangible assets like real estate. Alternative investments based on physical assets are usually safe and stable, even if the stock market turns bearish.
With that said, there isn’t a complete disconnect between alternatives and the broader market. Certain types of alternative investments will do better in a market downturn than others. If you’re concerned about market volatility or want to hedge your portfolio against a potential crash, consider precious metals, real estate and private equity as investment options.
They Are Much More Affordable Than They Used to Be
At one time, alternative investments were purchased almost exclusively by institutional and high-net-worth investors. Some of the items previously mentioned on the list of alternative investments were even restricted for ordinary investors. Until the implementation of Title III of the JOBS Act in 2016, for example, only wealthy, accredited investors could put their money into startups or small businesses via equity crowdfunding.
Fortunately, alternative investments are rapidly becoming more democratized. Ordinary investors are now able to purchase non-traditional assets freely, and many platforms have shifted their minimum investment requirements to accommodate users with small amounts of capital. While not all alternative investments have such low barriers to entry, the variety of low-cost alternatives is much larger today than it was even a few years ago.
They Make Room for Investors’ Priorities
Aside from being useful in building your wealth, non-traditional investments can also help you allocate your money profitably while meeting non-financial goals. If you are passionate about a certain kind of business, for example, you can make money by purchasing equity in a related startup. Likewise, you can fund film or art projects that you believe are worthwhile with fractional investing.
While the overall goal of investing in alternatives is still to realize a good return on your money, the ability to fully control where your capital goes is a refreshing change of pace from the traditional stock market. Whatever your interests or values might be, there are alternative investments that will allow you to pursue them and make money at the same time.
Alternative investments can be complex and carry high levels of risk, but they also have huge potential when it comes to diversifying your portfolio and generating high returns.