If you follow the headlines, maybe you’ve caught a quirky—but sometimes useful—prediction from Elon Musk, Gary V, or someone on Reddit. And that coin with the dog(e) is cute—but is it an alternative investment you want to sink your financial teeth into?
Today’s markets are dynamic, to say the least. Just look at the most recent headlines—the crash of 2020, while not the worst stock market crash of all time, sent a wave of panic through the investment world with the sharpest single-day point drop in US history. It’s these types of events that spur investors to seek out other alternative investment options, such as real estate or NFTs.
What Are Alternative Investments?
Understanding the definition of alternative investment involves an understanding of how assets are classified and allocated.
An asset is classified and grouped according to its characteristics. Certain assets are considered core assets, such as:
- Cash equivalents.
In the most general sense, alternative investments or assets are ones that you cannot classify as belonging in the above classes. How much you invest in each of these classes is known as allocation.
What Key Characteristics Do Alternative Investments Share?
When compared to traditional investments, such as stocks, alternative investments tend to have higher fees and a minimum investment threshold. Transaction costs are typically lower. While stocks are tracked on exchanges, like the New York Stock Exchange (NYSE), NASDAQ or the S&P 500, alternative investments aren’t—meaning finding financial data you can verify is much more difficult.
Another characteristic of alternative investments different from traditional investments is liquidity—specifically, alternative investments are less liquid than their traditional counterparts. For alternative investments, valuation is much more difficult, especially for an asset that’s particularly unique as there may be a relatively sparse market for it.
Understanding the Alternative Investment
Institutional investors and individuals with high net worth are the typical alternative investment holders. This is for several reasons, such as:
- Alternative investments are complex.
- There’s little to no regulation of the market.
- Alternative investments tend to carry higher risk.
A lot of alt investments also require a large minimum investment. When compared with other investment vehicles, such as ETFs or exchange-traded funds, alternative investments also carry higher fees. Due to the nature of alt investing—fewer investors, less information—it’s tough to find data on how well a certain investment performs, which also means you’re not likely to find real, verifiable information advertising a specific alternative investment. Keeping all of this in mind, the cost-per-transaction is typically lower with an alternative investment simply because there isn’t as much turnover when compared to traditional assets.
The majority of alternative investments are relatively illiquid. For instance, you’d find it much tougher to sell a 100-year-old bottle of wine than you would 100 shares of Tesla simply because you’ll have fewer buyers. You might even find it difficult to price your bottle of wine because it might be rare, so you’d have:
- Limited resources to make a comparison. You might find other bottles of wine for sale on a site like eBay, but none quite like yours.
- Limited transaction data. Without other sales of your specific bottle of wine for comparison, there’s no way to know how much your bottle may have sold for in the past.
How Are Alternative Investments Useful?
If 2020, 2021—and even 2022—were any indication, markets are volatile. Savvy investors turn to alternative investments because these investments tend not to correlate with the stock market, maintaining their value even when stocks are plummeting. Plus, inflation avoidance is possible with assets like gold and real estate. Portfolio diversification with alternative assets could be a smart move, and there are several reasons why, such as:
The gods over at the IRS tend to smile more favorably on income generated from alternative investments than they do on more conventional investments.
The Conditions Are “Just Right”
Certain conditions at the time of investment can carry significant weight down the road. For instance, say you can get in on a deal that seems almost too good to be true (like the deeply discounted real estate in the aftermath of 2008). Alternative investments like this can be well worth it, especially when you think the value could be substantially higher in the future.
Say you have unique or extensive knowledge in a particular area, alternative investments in that area would make sense for you. For instance, if you’re experienced in the oil industry and you have the know-how—and, ultimately, the patience—to invest in an oil slump, your knowledge could pay off beautifully.
On the other hand, imagine that the world of Egyptology either emotionally or intellectually piques your interest and you have the opportunity to invest in a startup that seeks to connect average people with archaeological digs. (Cool idea, right? Let me check if that exists already.) You might be drawn to this form of alternative investing because it speaks to you more than, say, investing in stocks or bonds. And you wouldn’t be alone—many investors enjoy seeking, finding and funding startups that mean a little something more than your average entrepreneurial endeavor.
It’s All About Control
For some investors, investing in the stock market is akin to throwing your money into the wind and hoping some of it blows back your way. Rather than stocks or bonds, these investors choose to invest in something they can assert more control over, such as real estate. For most, it’s an easier investment vehicle to understand, especially compared with the volatility of today’s markets.
Ahem, copyrights. Some alternative investors acquire such things as music copyrights. This can happen at an auction, as part of a negotiated transaction or through a court proceeding. Acquiring these kinds of bragging rights comes with a bit of responsibility, though—you should know how to offer licensing to artists when necessary.
While most alternative investors opt for a fund when investing in something like gold or silver, others enjoy the physical collection of these precious metals and will curate a physical collection of jewelry and coins.
Pros and Cons of Alternative Investments
Alternative investments are alluring for many reasons, especially to individuals with a high net worth who are intrigued by a subject and seek to transform it into a worthwhile investment. Here are some of the most prominent advantages and disadvantages of alt investments.
Advantages of Alternative Investments
There’s nothing like going all-in on an investment in the stock market based on a sure-thing tip, only to lose your entire investment to a market crash. Typically, an alternative investment isn’t connected to stocks, so you can diversify your portfolio, stave off volatility and even uncover some potential tax benefits.
Any form of investing has its potential for less than stellar return rates, but the cool thing about alternative investments is there’s greater potential to see even better returns than you would have by betting on the next unicorn stock. Those who swear by alternative investments consider these vehicles more sophisticated than traditional stock trading.
Some other pros of alternative investments include:
- Less volatility overall
- Portfolio diversification
- Better potential performance
Disadvantages of Alternative Investments
On the flip side, alternative investments might not be for everyone. Some of the cons of this investment type include:
- Private, illiquid investments. Because the majority of these investments are typically private acquisitions or sales, liquidity is lost. Your money could be tied into the investment for an unknown amount of time. Should you want to resell, you might find it tough to exit.
- No regulation. Because these are usually private sales, there’s no regulation. Thus, there also aren’t any requirements for reporting. Additionally, the actual asset of the investment might not be easy to value, which poses pricing and transparency challenges.
- Large minimum investment. A lot of alternative investments require a large minimum investment and therefore may not be within reach for every investor. You’ll also face higher fees in some cases, too.
- Complexities. An alternative investment is a multi-faceted investment vehicle and, as such, typically requires much more stringent due diligence.
For all the reasons above, it’s necessary to review your options and make alternative investment choices wisely. It’s a more exciting world with many more possibilities, so do your homework!