Let us define alternative investments.
When we think of investments, we think of stocks, bonds, and cash. Aside from these conventional ones that we know, more financial assets fall under these types, and we call them alternative investments. Some examples include hedge funds, private equity, venture capital, managed futures, art, antiques, commodities, derivatives contracts, real estate, and more. If an asset is tangible, then it is most likely an alternative investment. SEC does not usually monitor them, and they are not as liquid as other types of investments.
Who can have access to these alternative investments?
We have mentioned that these investments are less regulated. They also pose a degree of risk which is why only accredited, qualified, and institutional people are mostly the ones who own them. They are wealthy people who can handle the complexity of the investments. The minimum investment and fee structure are considerably high compared to other assets like a mutual bond or ETFs (exchange-traded funds). On the brighter side, owners can attest that the transaction fees are usually lower than the transaction fees of conventional assets. These assets do not usually publish their performance, nor do advertising for potential investors.
Alternative investments and illiquidity
Imagine this: you have an antique item worth $1,000 and $1,000 worth of Facebook stocks. Which between them do you think will sell faster? That is what we thought. Between the two, more people might be willing to buy Facebook stocks than an antique. So, this makes alternative investments primarily illiquid. Liquidity is how easy it is for an asset to be converted to cash without the market price being affected.
Pros and cons of alternative investments
There are various benefits that an investor can get from alternative investments. An alternative investment is the same as a conventional investment when it comes to weight. It will diversify an investor’s portfolio and can bring high returns. Let us not forget that it can also hedge inflation.
On the other hand, they also have their fair share of disadvantages. We have mentioned some of them earlier already. They are illiquid, high-risk, and unregulated. Also, it might be a challenge to give them value.
Should I consider alternative investments?
Alternative investments are not that correlated to conventional ones like stocks and bonds. Hence, these investments will add diversification to an investor’s portfolio. We have also mentioned that they can hedge inflation. For instance, hard assets like gold, oil, and real estate decrease fiat money’s buying power. Hence, most massive institutional funds like private endowments and pension funds dedicate even just a tiny portion of their portfolios to alternative investments. And we say small portion; we talk about more or less 10%.
If you are thinking about alternative investments, know that they pose higher risks. However, the risk is higher for a reason. It means that the possible return will also be higher. But before anything else, know that some of these alternative investments need you to be an accredited or a qualified person to become an investor.