When most people think of investing, they tend to think of stocks, bonds, and mutual funds. However, there are many other investment options out there that may be more suitable for certain individuals’ goals and risk tolerance. These are known as alternative investments. In this article, we will explore what alternative investments are and why you should consider them.
What Are Alternative Investments?
Alternative investments are investments that do not fall into the traditional asset classes of stocks, bonds, and cash. These assets can include real estate, commodities, private equity, hedge funds, collectibles, and even cryptocurrencies. Because they are not publicly traded on the stock market, they tend to be less liquid and have lower trading volumes. As a result, they can offer higher potential returns but also carry higher risks.
Why Consider Alternative Investments?
Diversification: Alternative investments can provide diversification to your portfolio. By investing in assets that do not move in tandem with the stock market, you can reduce your overall portfolio risk. For example, if the stock market experiences a significant downturn, a portfolio that includes alternative investments in real estate or commodities may not be as severely impacted.
Higher Returns: Alternative investments can offer higher potential returns than traditional investments. For instance, according to a recent report by the National Council of Real Estate Investment Fiduciaries, real estate investment trusts (REITs) have averaged a 9.9% annual return over the past 20 years, compared to the S&P 500’s 6.6% return over the same period.
Hedge Against Inflation: Certain alternative investments, such as commodities, can serve as a hedge against inflation. When inflation rates rise, the value of paper currency tends to decrease. However, the value of commodities such as gold, oil, and agricultural products tends to increase.
Portfolio Customization: Alternative investments can offer unique opportunities for portfolio customization. For example, a private equity investment may allow you to invest directly in a specific company, giving you more control over your investments.
Potential Drawbacks of Alternative Investments
Higher Fees: Alternative investments tend to have higher fees than traditional investments. For example, hedge funds often charge a management fee of 2% or more, plus a performance fee of 20% of profits. Additionally, private equity investments often require a minimum investment of $100,000 or more.
Illiquidity: Many alternative investments are illiquid, meaning they cannot be easily bought or sold. For example, if you invest in a private equity fund, you may not be able to withdraw your funds for several years. This lack of liquidity can be a disadvantage if you need to access your funds quickly.
Higher Risk: Alternative investments tend to carry higher risks than traditional investments. For example, investing in a start-up company through a crowdfunding platform can be a high-risk, high-reward proposition. Similarly, investing in a commodity can be risky if the price of the commodity falls unexpectedly.
Conclusion
Alternative investments can provide investors with opportunities for diversification, higher potential returns, and portfolio customization. However, they also come with higher fees, illiquidity, and higher risks. If you’re considering alternative investments, it’s important to do your research and fully understand the risks involved. In general, alternative investments are best suited for experienced investors who are comfortable taking on higher risks and have a long-term investment horizon.