Investing Outside the Box: Alternative Assets
Know the risks, tax rates, and viability before you dive in
The term “alternative investment” simply refers to an investment being an alternative to stocks and bonds. Both an unboxed Star Wars figurine with appreciating value and a run-down local warehouse could fall under the definition of an alternative investment.
Common forms of alternative investments include private equity or venture capital, cryptocurrency, hedge funds, managed futures, art and antiques, commodities, and derivatives contracts. Real estate is also often classified as an alternative investment.
Most alternative investments are subject to fewer regulations from the U.S. Securities and Exchange Commission (SEC) and tend to be somewhat illiquid, meaning they are not easily sold and converted to cash.
That said, alternative investments can help keep your portfolio balanced if leveraged carefully. Here’s what you should know.
UNDERSTANDING ALTERNATIVE INVESTMENTS
Many alternative investment assets are held by institutional investors or accredited high-net-worth individuals because of their complex nature, lack of regulation, and degree of risk.
Many alternative investments also have high minimum investments and fee structures, especially when compared with mutual funds and exchange traded funds (ETY%). These investments also have less opportunity to publish verifiable performance data and advertise to potential investors.
Although alter native assets may have high initial minimums and up-front investment fees, the transaction costs are typically lower than those of conventional assets due to lower levels of turnover.
Most alternative assets are fairly illiquid, especially compared to their conventional counterparts.
For example, investors are likely to find it consider- ably more difficult to sell an 80-year old bottle of wine than 1,000 shares of Apple, due to a limited number of potential buyers.
Investors may have difficulty even valuing alternative investments, since the assets and transactions involving them are often rare. For example, a seller of a 1933 Saint-Gaudens Double Eagle $20 gold coin may have difficulty determining its value, as there are only 11 known to exist but only one that can be legally owned by an individual.
TYPES OF ALTERNATIVE INVESTMENTS
Real Estate
Real estate as an investment includes investing in physical properties or property-based securities such as real estate investment trusts (REITs), real estate mutual funds, or crowdfunding platforms. In addition to capital appreciation of tangible assets, real estate investors strive for operating income to potentially provide ongoing stable cash flow:
Commodities
Commodities are raw materials such as gold, silver, oil, and agricultural products. Investors can invest in these tangible goods that have real-world uses and often perpetual demand due to the underlying characteristics of what they are. For example, the price of gold is arguably more stable because it’s used in a variety of industries.
Pros and Cons of Alternative Investments
PROS |
CONS |
||
| May offer diversification benefits | Are often associated with higher fees and transaction costs | ||
| Often have higher return potential than traditional investments |
Often have higher risk than traditional investments | ||
| May offer protection against inflation | Often lack regulation or transparency | ||
| May allow investors to more specifically select investment preferences | May be more volatile than traditional investments | ||
Art and Collectibles
Some investments may double as a hobby, with art, sports memorabilia, entertainment memorabilia, or other collectibles acting as alternative investments. These items may have historical worth or develop worth over time as related parties (i.e., the artist, associated movie star, or associated athlete) become more historic.
Cryptocurrencies
Cryptocurrencies such as Bitcoin, Tether, and Ethereum surged in popularity over the past few years, but they are still considered alternative assets and are largely unregulated in the U.S. Though some claim cryptocurrency does not offer a strong hedge against other risk-on investments, it may provide capital appreciation or passive income due to staking rewards.
Venture Capital/Private Equity
Blurring the lines of an alternative investment, venture capital or private equity is simply a refined branch of stock investments. Instead of trading shares of public companies in an open market, investors may seek alternative avenues to put capital
into private companies or startups.
REGULATIONS
Even when they don’t involve unique items such as coins or art, alternative investments are vulnerable to investment scams and fraud due to the lack of regulations.Alternative investments are often subject to a less-clear legal structure than are conventional investments. They do fall under the purview of the Dodd-Frank Wall Street Reform and Consumer Protection Act, and their practices are subject to examination by the SEC.
However, they usually don’t have to register with the SEC. As such, they are not overseen or regulated by the SEC the way mutual funds and ETEs are. So it is essential that investors conduct extensive due diligence when they are considering investing
in alternative assets.