Alternative investments (also referred to as alternative assets) are any asset classes that aren’t stocks, bonds, or cash.
In this article, we’ll look at what alternative investments are, the different types of alternative assets, characteristics and how they differ from traditional investments, and the risks and rewards of investing in them.
Characteristics of alternative assets
There are many different types of alternative investments, and they all have a few characteristics in common.
Less liquidity than traditional assets: Some alternative assets, like major cryptocurrencies, have highly liquidity at all times. However, some investments, like real estate or private equity shares, can be more difficult, and take a longer time, to find a willing buyer to take them off your hands.
Lower correlation to standard asset classes: Traditional assets are extremely correlated with market movements. Alternative assets have a lower correlation to public markets and can be a good hedge against traditional asset investments.
Less historical risk and return data: Many alternative assets are new, like cryptocurrencies and NFTs, and may have less historical data to base your investments on.
Less regulated by the SEC, unique legal and tax considerations: Traditional assets are heavily regulated by the SEC, while alternative assets have less regulation and can come with legal and tax considerations that you normally wouldn’t have to think about with traditional investments.
Higher risks, higher rewards: Alternative assets can be riskier to invest in, but the rewards could be greater than more conservative traditional investments like bonds or mutual funds.
Because of these characteristics, most alternative asset investments are typically owned by high net worth people, accredited investors, and institutional investors.
Alternative Investment Types
Commodities are mostly natural resources, such as oil, natural gas, precious metals, and agricultural products. Commodities have been traded for thousands of years, and are a hedge against inflation because they have a very low correlation with the public markets. The value of commodities changes based on supply and demand.
Real estate includes both residential and commercial properties, and is the biggest asset class in the world. Property owners benefit from passive income from tenants paying rent, and the value of the asset usually increases in the long-term.
Collectibles can be anything from art, vintage wine, sports cards, stamps, coins, and even rugs. Investing in collectibles as an alternative asset class requires expert knowledge in valuation, knowing how to spot fakes, and a clear understanding of how to properly maintain the asset while you own it. Collectibles can be much less liquid than some other alternative investment types.
Cryptocurrencies are still relatively new to the alternative investments scene, and are less regulated by the SEC. While it used to have a lower correlation with public markets, recent price movement has been highly correlated with inflation. Many people are no longer viewing them as a hedge against inflation.
Futures contracts, options, and forwards are types of derivatives that can be classified as an alternative asset. You’re not holding any shares of a company directly, but are betting against the rise or fall of the share price.
Private equity refers to investing in private companies not listed in public markets, and can include anything from venture capital, growth capital, and buyouts of the entire business. Private equity comes with higher risk, and a lot more active investing, but historically has provided some of the highest returns of any asset class.
Both public and private companies can borrow money from private debt funds, who make money through repayment of the loan, interest payments on the debt, and sometimes even a small percentage of equity in the company.
Risks and rewards of investing in alternative assets
The characteristics of alternative assets are what make them riskier (and potentially more rewarding) than traditional assets. Because they can be less liquid, require expertise in order to make smart investments (like with collectibles and cryptocurrencies), and don’t have as much historical risk and return data, alternative investments come with higher risks than traditional investments.
But while many people view alternative investments as riskier asset classes than traditional assets like index funds, they can also provide portfolio diversification and lower the overall risk, while giving you the potential for higher returns.
Many alternative investments, like private equity, are only available to accredited investors. However, many asset classes are becoming more openly available to the general public (for example, anyone can invest in cryptocurrencies, real estate, and collectibles). And while it’s not as straightforward as investing in something like public market index funds, the user friendliness of new investment platforms are making alternative investments increasingly accessible for everyone.
Did you know you can invest in alternative assets with a retirement account? If you’re self-employed, the Ocho Solo 401k Plan gives you checkbook control, the highest contribution limits, and the ability to invest in any asset class with tax-free compounding.