Most smart investors and wealth managers will tell you never to put all your eggs in one basket. Your long-term financial success needs to have a diversified portfolio as it mitigates risk from the sudden collapse of a single sector.
This brings us to the topic of alternative investments.
These investments earn you a healthy return while keeping your risks at a manageable level. When done correctly, alternative investments can be a significant portion of your wealth maximization strategy.
In this article, I’ll review factors of alternative investments and consider six alternatives that can give you a good ROI.
6 Best Alternative Investments
Alternative investments have made a comeback in recent years, mainly due to the crashes and volatile nature of the stock markets.
Whether it is the boom in the real estate market, the appreciation of gold prices, or the rise and fall of cryptocurrencies, we can see that investors are looking at places other than the stock market for generating wealth.
We consider six alternative options for investment that can offer high returns for investors:
Investment in fine art can be a substantial investment because the prices in this sector are not affected by the ups and downs of the stock market. Over the past decade, the value of art has steadily increased.
The aggregate stock market has also risen during the same period at a high rate. Even though the art sector and stock market don’t rise and fall at the same time, the art market still goes through shifts that can make investments in the sector risky.
Masterworks is an investment platform built for investors who are looking to buy and sell art. It facilitates liquidity in the market and thousands of investors use the platform every day.
Real estate is always a good option for investment. The importance of real estate and its central role in the economy was felt during the 2007-2008 financial crisis.
Fundrise has built a platform that invests exclusively in real estate while giving investors the same level of control and liquidity that they might get from investing in the stock market.
All investments are long term with a period of three to seven years on average. A higher rate of return is offered on long-term commitment. The company’s current average rate of return per year is 11.44%.
RealtyMogul is another real estate investment platform that offers data-driven growth solutions for investors. The fund carries out extensive research and surveys on commercial properties to assess profitability for investors.
They provide an easy four-step process for signing up and allow investors the freedom to review, compare, and invest in real estate properties that meet their investment goals.
The company is mainly focused on commercial real estate. Investment options include public, non-traded REITs, individual properties, and 1031 exchanges.
Betterment is one of the more successful robo advisors that have sprung up in recent years. It is an alternative to investing in the stock market through your financial advisor. The company started in 2010 and currently managing a fund that is valued at $18 billion.
The minimum investment limit is $0, and the FDIC insures the fund for up to $250,000.
Wealthfront is another investment tool that gives people an alternative to investing in the stock market. With a total fund size of over $18 billion, it has become one of the most prominent robo advisors in the market.
The minimum investment amount is $500, and the fee is quite low, at 0.25% for the savings account. The fund invests in diversified stocks, bonds, and ETFs.
The Lending Club Corp was started in 2007 by a group of financial experts as a premier player in the P2P lending market. Lending Club is a major online marketplace that helps connect borrowers and lenders directly. The total value of loans issued by the firm as of March 2018 amounted to more than $35 billion, making it one of the biggest online lending platforms.
The platform allows borrowers to get loans for various purposes such as personal finance, debt consolidation, credit card pay-off, home improvement, business loans, medical financing, and investments.
The minimum value of the loan amount that can be offered on the platform is $1,000 for individuals and $15,000 for businesses. The maximum values of loans go up to $40,000 for individuals and $300,000 for companies.
The company became one of the first publicly traded online peer-to-peer lending companies in the U.S. after its successful IPO in December 2014. The current market capitalization of the company is over $1.8 billion.
What Are Alternative Investments?
Alternative investments are a class of investment assets that do not fall into the traditional categories of investment class of assets. The conventional investment assets include cash or cash equivalents, company stocks, or bonds. Common examples of alternative investments include:
- Real Estate
- Real Estate Investment Companies
- Estate Development Corporations
- Master Limited Partnerships that own or operate oil pipelines or capital-intensive services such as theme parks
- Commodities Including Gold, Metal, Oil & Gas, Agricultural Produce, etc.
- Investments in Mineral Deposits
- Forest Holding Corporations
- Investments in Timber Factories and Lumber Yards
- Investments in Intellectual Property Including Patents, Trademarks, Movies, Song Rights, Research, etc.
- Leases in Equipment
- Hedge Funds
- P2P Lending
- Tax Credits
Generally, there are two main types of alternative investments:
- The first involves holding investment concerns that invest in non-traditional assets such as real estate, infrastructure, or farmlands.
- The second type includes investing in traditional assets through non-traditional means such as hedge funds, tax credits, and short-selling.
Differences between Regular and Alternative Investments
There are significant differences between traditional and alternative investments. Here are some of the characteristics of each:
- Greater liquidity for the investment
- Assets are held for buying and selling in a public market
- The value of the assets fluctuates with changes in the market
- It is a passive type of investment where the owner has little control over the business operations
- These investments have lower liquidity
- Alternative assets can be held in both public and private markets
- The value of assets has a low correlation to market
- Asset owners are often active shareholders, directly taking part in business operations
- Investors focus on profiting through inefficiencies in the market
Advantages of Alternative Investments
Alternative investments have several advantages that make them attractive options for investors. In most cases, the value of alternative investments is not affected by the market.
Even if the values of the stocks are falling in the market, the alternative investment values remain stable or go up. This helps counterbalance market volatility and sudden crashes.
Alternative investments can also offer several tax benefits that are otherwise unavailable with regular investments. For example, the government often subsidizes agricultural businesses or charges taxes at zero-rate to boost production to keep food prices down.
The rate of return for alternative investments is not guaranteed and it can go up or down due to market factors. However, data suggests that alternative investments always perform better than regular assets during a downturn or recession.
There have been a lot of developments in alternative investments in the last couple of decades. Supporters of alternative investments argue that they now have access to sophisticated investments and offer higher returns to individuals today than was only possible for institutional investors ten years ago.
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- Possibility of tax-exempt cash flows
- Market inefficiencies offer more significant profit opportunities for smart and active investors
- Greater control of assets
Disadvantages of Alternative Investments
Alternative investments are often more complicated than traditional investments, and you need expert knowledge of the asset class to derive meaningful benefits.
Consider hedge funds and real estate. Both these investments require you to have an advanced understanding of how the assets work before you consider purchasing anything.
Alternative investments have a higher fee for the transaction than regular investments. These investments also do not have the same level of liquidity that you get with stocks or bonds. Once you have committed the funds, you are often required to keep the investment for a period of two to five years to get a good return.
As with any other investment, the higher rate of possible return on alternative investments means there is a higher risk of loss as well.
- A possibility that you may receive negative tax consequences
- More complex investments
- Inefficient markets
Why Investors Choose Alternative Investments
There are many reasons why investors and portfolio managers consider adding at least a few alternative investments to their investment portfolio.
In several cases, the money generated through alternative investments gets more favorable tax advantages than you would get from a traditional investment.
For instance, if an investor has allowable tax losses carried forward from previous years or tax credits for the year, they can be applied to a specific type of investment activity or head of income.
There are also cases where conditions specific to a particular asset class might make the asset appear much cheaper for investment than other types of investments that can be purchased in the market.
For example, after the fallout from the recession, many wealthy investors bought deeply discounted condos in cities like Miami and paid only a fraction of what they considered the ultimate market value would be for the properties in the future.
Some investors, and their financial advisors purchase alternative assets because they have in-depth knowledge or specific skills in that area. Thanks to their better understanding of the asset class, the investment makes a lot of sense.
As an example, suppose there is an experienced entrepreneur who understands the oil and gas industry. They have the resources and patience that can help them take advantage of a significant oil or gas deposit, so investing in land with potential reserves can pay off handsomely for them.
Alternative investments are not always motivated by profit. Some investments in alternative assets might be driven emotionally and intellectually. These assets capture the attention of the investor more than other asset classes, even when they are not very profitable.
For instance, consider the investments in green technology that have not become as efficient as fossil fuels despite billions of dollars in funding.
Investors who are deeply drawn to environmentally-friendly projects enjoy the process of locating, identifying, financing, and growing green startups. The government also incentivizes them due to massive tax breaks.
Some investors opt for alternative assets because they do not like the idea of owning stocks and bonds where they do not get a lot of control. They prefer to underwrite their mortgages on real estate properties that they acquire and renovate for selling off later.
The greater control and ability to determine profit makes sense to certain types of investors. The potential gains and losses are easier to understand, especially if we compare them to the daily volatility and market fluctuations of owning the publicly-traded common stock.
Some investors purchase jewelry, paintings or antiques, either at an auction, in negotiated transactions, or through bankruptcy court proceedings. These are long-term investors who understand how to derive value from holding vintage artifacts and selling them later at a profit.
Perhaps the most popular type of alternative investment is made in commodities such as gold and silver. These investors are often called "Gold Bugs." They buy and hold gold bullion in coin and bar form for profitability.
For many investors, these metals become a kind of obsession as they accumulate more and more of them. Investors who do not invest in metals may dismiss this behavior as irrational because it does not make sense to them, but those who have invested in gold or silver have told stories of building a considerable profit from their investments.
You can see that there’s quite a bit of value to putting money into alternative investments. I’ve laid out just six options here, but there are plenty more. The point being is look for unconventional ways to further diversify your portfolio and mitigate risk as much as possible.