An investment portfolio can paint a clear picture of a person and their goals for the future. Traditional investors might limit their selections to asset classes such as stocks, bonds, and cash. However, for those savvy investors looking to both embrace innovation and fill gaps in their portfolios, there are other options. Specifically, many people are looking at alternative investments to capitalize on available wealth-building opportunities.
Alternative investments are any disparate asset that is not the traditional publicly-traded option of a bond, stock, cash, etc. However, some alternative investments are still considered a common vehicle to pursue, such as real estate or commodities.
They are simply outside the traditional investment avenues. Some typical alternative investments are hedge funds, cryptocurrency, private equity, venture capital, derivative contracts, managed futures, and tangible assets such as antiques and art.
Types of Alternative Investments
Different investments offer varying rewards and risks. There may also be different lengths of time when the money is locked in before an investor can access it. When diving into alternative investments, you want to be sure to establish an alternative strategy suited to your needs and desired level of risk.
When considering real estate investing as an investment strategy, this option usually refers to investment properties. The properties may consist of residential apartment buildings, office buildings, or mixed use.
Real estate is ideal for people who are looking to gain value from the property when rental rates increase and properties gain valuation. Yet it does require work to become a landlord to properly manage this investment option.
For those who are not interested in becoming tied directly into the daily management of properties, private real estate investment trusts (REITs) can be another option as these are typically purchased through brokers. Investing directly into a fund or REIT frees you from the landlord responsibility as an alternative investing strategy.
Cryptocurrency is a digital form of currency powered by blockchain technology. Blockchain essentially works by recording each asset transaction as a “block” of data and forming a chain to show a clear timeline of ownership. Blockchain technology has been receiving a great deal of attention in the financial sector due to its security strengths. This security is essential to cryptocurrency.
Research is needed when selecting what type of cryptocurrency to invest in. The most commonly known types are Ethereum and Bitcoin, but there are thousands of options to choose from.
While cryptocurrency might seem unstable and intangible, the potential for wealth is very real. What was once trendy speculation has become mainstream enough to have earned strong consideration for rounding out investment portfolios.
Commodities refer to assets that do not fluctuate the same on the market as stocks and bonds. These investments may involve metals such as gold, agriculture such as corn, or energy such as crude oil.
These investments handle rising inflation well, as they are often called an inflation hedge, and come to maturity at different times of the year. The commodities are sold in the futures markets, yet many are also available through exchange-traded funds (ETFs) which are more liquid than mutual funds.
The hedge fund industry is a desirable option for investors. Hedge funds are pooled investment funds. They are categorized by strategy: relative value, equity hedge, macro, event drive, and many others.
These strategies may be risky and non-traditional, as a high minimum investment is necessary. They are actively managed "bets" that try to beat the average returns in favor of the client.
These alternatives are often set up as an investment limited partnership (ILP) that is private and only upon a limited set number of investors who are accredited. With a hedge fund, an investor may invest in a company in the hopes it appreciates in value, yet also take a portion of their investments and bet against the company's appreciation if the value drops in value. In this manner, the investor will generate hedge fund returns in their favor no matter how well or how poorly the company appreciates.
Unlike publicly traded shares in companies, private equity investments focus on non-publicly traded companies. Capital becomes invested in these companies which may be used in different ways such as bolstering a balance sheet, making an acquisition, purchasing new technology or expanding on existing capital.
Some private equity ventures also consist of investors buying out companies to delist them from the stock exchange. Investors in a private equity fund consist of general partners who take on the full liability and limited partners who own the majority of the shares.
Startup investing, also known as venture capital, is similar to private equity, as it’s a sub-category of the aforementioned alternative investment. Investors take their capital and invest in companies that are still in the early stages of growth.
The investor typically seeks a company about to experience outsized growth or to expand rapidly in their industry segment. Investors may also look at companies with the potential in developing the latest innovations. If the companies succeed, there is a high chance of investor reward.
Like many other financial sectors, technology has provided access for small-time investors to access avenues formerly only available to very wealthy individuals. This is accomplished both through direct access via crowdfunding platforms and raised non-accredited investor fund limits. If retirement investors use their tax-advantaged funds to invest in a startup, there can be major financial benefits if the startup experiences a windfall.
Unlike private equity where an investor places capital toward the appreciated value of a business, private debt investments involve an investor placing their funds into purchasing the business debts. A private debt investment often covers any loan that was acquired to fund operations and equipment.
The investor obtains returns on the interest of the loan. Private debt is not traded on the market and may also involve private bonds. It may provide an alternative to companies that do not seek traditional loans through banks and other financial institutions.
Benefits of Alternative Investing
Alternative investments allow people to pursue portfolio diversification. They are not only reserved to accredited investors. Many younger investors and people getting their feet wet in the market can get involved with these options as they have become more democratized.
Many alternative investments are not liquid, as they cannot be easily converted into cash. The vehicles can potentially generate higher yields while also being more predictable when providing income.
Even if the market fluctuates and stocks fall, alternatives do not behave in the same way and tend to be less volatile. So including them in your investment mix adds a bit of protection to portfolios by cutting down on volatility as it does not behave in the same way as bonds and stocks that are directly tied into the state of the current market.
Challenges of Alternative Assets
Like traditional assets, alternative investments are still regulated by the Securities Exchange Commission. However, the securities do not have to be registered which reduces the transparency regarding the investments’ value. This lack of transparency and lower regulations can make pricing assets more difficult, meaning you might have to complete additional due diligence.
While many funds are only available to accredited investors, people getting into the alternative investment industry may also have access to these options. However, these investors must be wealthy and meet the Securities Exchange Commission’s requirements. People are required to have at least a $1 million or more net worth which does not include their primary residence or have a $200,000-$300,000 annual income.
Another key challenge to consider is the longer lock-up periods of funds. Investments may take up to 5 to 10 years before they reach maturity. If a person is looking to access the funds before those time periods, they may find themselves unable to make their investments liquid. In these instances, reviewing the lock-in period and selecting other alternative investments with shorter time frames may be more suitable.
Also, keep in mind that many investments are complex and could require a financial advisor who is well-versed in these possible vehicle options.
Best Practices for Alternative Investments
There are several things you’ll want to consider when getting involved with alternative investments. Some of the top steps to take include becoming educated on the asset classes and individual investments that align best with your investment strategy, understanding best practices on performing due diligence and finding and evaluating trusted providers.
1. Understanding Asset Classes
Alternative investment classes come in a wide variety. Some, such as commodities, have been in existence for long periods of time, while others are relatively new. If you are an expert in real estate but want to round out your portfolio with NFTs, you cannot simply apply the same strategies between the two classes.
Because of the vast differences in structure, market expectations, and regulations, each alternative asset class should be researched independently. Thankfully, there are numerous resources at your disposal. If your investment provider offers webinars, courses, or other educational opportunities, you should take advantage. Best of all, these resources tend to contain both conceptual and actionable information so you are able to apply what you’ve learned to your own portfolio.
Education should fill you in on not just how an asset class functions. You should also have a clear understanding why it is or isn’t a valuable resource for your purposes. Case studies can sometimes provide added insight as to how these investments operate in the real world and how the case in question might translate to your own situation. After all, knowing why you’re investing in each asset class is imperative for confidence in the overall health of your portfolio and future wealth.
2. Performing Due Diligence
Jumping into an investment on a whim or based on a throwaway mention from an authority figure is, at best, risky behavior. Before you throw your hard-earned funds into a new investment venture, you want to be sure you have reasonable expectations of the results. That’s where due diligence comes into play.
Due diligence is, in essence, doing the necessary research to get a comprehensive picture of the investment. This includes a multitude of aspects such as, but not limited to, the investment’s performance history, fees involved, competitor comparisons, and overall risk. If you only take one or two of these factors into account, you could be making decisions that serve against your overall goals.
For example, if you only look into a startup’s impressive two-year trajectory and decide to invest, you could be ignorant to underlying risks. If additional research uncovers the recent departure of an original founder, the investment may not be as solid as initially thought. So to avoid unexpected surprises, attempt to investigate all the components of the investment and participate with confidence.
3. Finding a Trusted Provider
When searching for a trusted provider, especially if you’re looking into alternative investments, your focus should be on integrity, value, and fit.
Your provider should, first and foremost, have your interests at the forefront of their priorities instead of their own. Practices such as steering you toward unstable investments without making you aware of the risks involved do not exhibit integrity.
There is also the matter of fees. Some providers might promise impressive growth in your investments but fail to mention exorbitant fees that might offset your wealth accumulation. Before trusting your money with a provider, make sure they are transparent about their fee structure. Whether they have a percentage or flat fee subscription setup, you should never be surprised by hidden costs.
If you have established that a possible provider is trustworthy, their investment selections still need to be of a certain quality. If not, it will be far more difficult to reach your goals of retirement or wealth accumulation.
Also in line with investments offered, you should firstly ascertain whether or not your preferred asset classes are even available. For example, engaging with a highly recommended provider who does not offer precious metals as an asset class is useless if you are very interested in gold. Making sure your goals and intentions are compatible with services and options available goes a long way toward finding a good provider fit.
For new individual investors who decide to do it on their own and seek out alternative investments through other avenues, such as on marketplaces, they need to understand the market asset class, challenges, and benefits of the investment product. For those who are still interested in alternative investments but are not experienced in the finer details, your provider should be able to help. Either by offering access to educational resources or making recommendations, a good provider should enable you to invest with sufficient knowledge and accurate expectations.
4. Tracking Performance
Lastly, even though the overall value of the fund may be obscured, an investor still has the opportunity to track its performance by creating benchmarks. For beginning investors, however, creating a benchmark might feel like wading in a pool of incomprehensible numbers and figures. Before you can feel comfortable in your assessment of an investment’s performance, you will want to utilize quality educational resources.
Depending on your preferred learning style, you can select from a variety of webinars, web series, published reference materials, or one-on-one expert instruction. Before making your selection, make sure that the material has been vetted by an authority in the field. If you’re specifically wanting to know more about tracking alternative investments, a resource specializing in those asset classes should be a priority.
Once you get a better grasp of how different investments operate, you’re ready to start interpreting corresponding data. There are indices available that track differing private equity, real estate, and hedge fund styles that may align to the fund's strategy.
Using these indices provides greater clarity to how well the fund is stacking up to others with similar strategies. Having that comparison can provide useful details regarding its risks as well as potential returns.
There are many benefits and challenges involved with alternative investments. Understanding your portfolio and the ways in which you wish to diversify may allow you to decide which alternative investments are the best option to take.
Investment Advice: Forget The Old “Rules of Thumb”
When it comes to financial “rules of thumb,” most of them were created decades ago and were very appropriate for the time in which they first existed. However, the financial world is a very different place from where it was in the 1900’s. Changing regulations, interest rates, and technological developments have made rules of thumb open to criticism.
One of the most common pieces of advice an American investor has likely heard is regarding the relationship between age and investment ratio. The rule states that you should start at 100 and subtract your age. Whatever number you end up with is the percentage of your portfolio that should be invested in equities. The remaining figure should be invested in bonds.
When this rule first came into existence, bonds had the potential for slow but reliable growth. In these modern economic times, bonds are unlikely to see substantial growth for another 10-15 years. Using alternative investments should be considered as an innovative and reliable way to round out your investment portfolio.
That’s not to say that you should transfer all your bond investments into art or cryptocurrency today. But taking a measured approach to alternative investments — anywhere from 10-40% according to Rocket Dollar CEO, Henry Yosida — is an option every investor should consider no matter your age.
How to Get Started in Alternative Investments
Is this all seeming right up your alley? When you're trying to make your investment decision and dive into the world of alternative investments, make sure you find the right platform and partner. With Rocket Dollar you can get started in diversifying your retirement portfolio today.