What are alternative investments?
Alternative investments are investments in an asset class other than typical categories like stocks, cash, and bonds. There's no exact qualification for what makes something an alternative asset, but investments like collectibles, real estate, private equity, commodities, and derivatives often fall under the alternative investment umbrella.
Typically, investors turn to alternatives to diversify their portfolios. But these alternatives can also help hedge against inflation and provide some downside protection if they're not correlated with the overall market.
Popular types of alternative investments
As mentioned, it's a bit difficult to pin down a complete list of alternative investments since definitions vary slightly. However, there are several popular, agreed-upon alternative investments you can consider.
1. Real estate
Real estate is one of the most popular alternative investments out there, and for good reason. For starters, real estate is traditionally a decent inflation hedge and way to diversify away from the market during downturns. Secondly, it can provide fixed-income for landlords or shareholders of income-generating properties.
There's also a range of ways to invest in real estate, including:
- Investing in a rental unit
- Using real estate crowdfunding platforms
- House hacking
- Investing in REITs
Between potential property appreciation and cash distributions, there's plenty of upside for this alternative investment. And crowdfunding companies and REITs are also making it easier to get in on the action without needing much capital.
Another alternative investment category that's been growing in popularity in recent years are collectibles. And, like real estate, crowdfunding platforms have joined the space to let investors purchase fractional shares of a range of assets.
Some of the most popular alternative investment platforms for collectibles include:
- Collectable: Lets you buy fractional shares in sports cards and other sports memorabilia.
- Masterworks: Invest in shares of fine artwork.
- Rally Road: Another alternative investment platform where you can buy shares of luxury cars, NFTs, comic books, and other niche collectibles.
- Vint: Lets you buy shares of fine wine starting with just $25.
- Vinovest: Another popular wine investing platform that also has automated portfolios.
And this is just a sample of what's out there. Nothing stops you from investing in a Rolex, rare Pokemon cards, or an ancient coin collection. Just note that the more speculative the asset, the greater the potential risks. And one common downside of collectibles is that they're often illiquid, so it can take months or years to find a buyer if you want to sell. Plus, collectibles don't generate income like real estate.
3. Private equity
If you've ever seen the show Shark Tank, you're probably familiar with this alternative investing strategy. The idea is to invest in promising businesses as an angel investor and to then benefit from potential company growth and a higher valuation down the line.
Traditionally, this alternative investment has only been available to venture capital firms or immensely wealth individuals. But just as crowdfunding is disrupting real estate, it's also made its way to startup investing. Platforms like OurCrowd and SeedInvest let you invest in a range of startups across sectors like technology, healthcare, food, and more. And you don't need to have millions of dollars to get a seat at the table.
One downside worth noting is that private equity can be very risky. And, unless a business gets acquired or begins generating enough cash to pay shareholders, you might not see returns for years. Plus, many platforms still require being an accredited investor to join.
4. Hedge funds
While hedge funds are traditionally only open to accredited investors willing to invest large sums of money, they're still one of the most popular alternative investing options. This is because a hedge fund can invest in pretty much anything, ranging from regular stocks and ETFs to alternative assets like crypto and real estate.
And like the name suggests, hedge funds “hedge” portions of their portfolios by shorting certain positions. This helps reduce risk and provide more stable returns, even if the overall market is down.
This is a fairly simple explanation, and different hedge funds and fund managers may use different techniques of varying risk levels. But ultimately, hedge funds make money by taking management fees and performance fees, so their goals are aligned with investors.
Cryptocurrency has become one of the hottest alternative investments of the last few years. If you were an early adopter of major coins like Bitcoin and Ethereum, you probably outperformed any other asset class by a longshot.
However, cryptocurrencies are also one of the stranger alternative investments. This is because crypto isn't as good of an inflation hedge as previously thought and Bitcoin has become increasingly correlated to the stock market over time.
That said, you can still consider diversifying some of your portfolio with crypto if you believe in the underlying blockchain technology and that crypto is here to stay. And major crypto exchanges let you buy crypto with funds right from your bank account, so getting started is simple.
Another classic alternative investment people often turn to during periods of high inflation or to diversify are commodities. Gold and silver are really the two poster children for commodities. But you can also invest in commodities like agricultural products, oil, livestock, and similar raw materials.
One advantage of this alternative investing strategy is that commodities don't always correlate with market movements. So, you can park some of your portfolio in assets like gold and potentially ride-out a downturn.
However, one disadvantage of commodities is that they don't typically produce income. Thankfully, you can get around this with options like gold ETFs or investing in companies directly involved in commodities that pay dividends.
7. Private debt
While sometimes on the riskier end of the spectrum, debt-based investing is another alternative investment you can consider. And there's numerous ways to get started.
Peer-to-peer lending is one popular example whereby investors lend money to individuals instead of going through an intermediary like a bank. There's also alternative investing platforms like PeerStreet and Groundfloor that let you fund real estate debt in exchange for interest payments.
Venture debt is another example that harkens back to the startup investing idea. But the overall idea is the same: you can potentially generate returns by lending out capital. The main risk is that your borrower defaults and that you can't recover any or all of your loan.
One final alternative investment you can consider are derivatives. These are financial contracts where the value depends on an underlying asset or group of assets. As the underlying asset changes in price, so too does the derivative.
Futures contracts, swaps, and options are popular examples of derivatives. Derivatives are often used by hedge funds or traders to help manage risk. However, retail investors can also experiment with options trading or futures through many leading online brokers.
Just note that there can be immense risks with derivatives since value depends on the underlying asset value. So, if you hedge your bet incorrectly and prices change inversely to what you thought, you could lose an astounding amount of money. And if you're trading on margin, you could lose even more money than you invested in the first place.
What are the requirements to buy alternative investments?
Historically, alternative investments have only been available to institutions like hedge funds or accredited investors. To qualify as an accredited investor, you must have an annual income of at least $200,000 (or $300,000 with a spouse) for the past two years or by having a net worth of at least $1 million.
However, the rise of crowdfunding platforms is making alternative investing more accessible. Platforms like Fundrise let you invest in real estate with just $10; Masterworks, Vint, and others have similarly low requirements. And since more platforms are dropping accreditation requirements, there's really no barrier to entry for many asset classes.
What are the tax implications?
Unfortunately, there's no one-size fits all taxation law for alternative assets because they're so different. Really, how your investments impact your taxes depends on their classification and if they produce income. Investing through platforms can also have different tax implications depending on how the platform issues shares and income.
And sometimes, it takes time to figure everything out. For example, the IRS has been slowly wrapping its head around crypto and NFT tax laws. As it stands, events like creating NFTs aren't taxable, but crypto-to-crypto transactions like selling an NFT are. And if you create and sell NFTs for your job, it could be considered self-employment income. Talk about confusing.
Ultimately, you need to read the terms and conditions of platforms you're investing with if you go the crowdfunding route. As for DIY investors, consider speaking with a financial advisor or accountant to learn how your alternative investments may impact your taxes.
Pros and Cons
- Helps create a diversified portfolio
- Can serve as an inflation hedge
- Potential to outperform the market
- Crowdfunding platforms are lowering the barrier to entry for investors
- Many alternative investments are illiquid
- Some platforms or assets still require accreditation or large amounts of capital
- Certain alternative investments don't produce income
- Potential tax implications
How to get started
As mentioned, there are numerous crowdfunding platforms that specialize in various alternative asset classes. And you can also invest in assets like REITs or commodities through most online stock brokers. It's the more niche alternatives like collectibles or private equity that can take more time and due diligence to land a deal.
If you want a simple way to explore numerous alternative investments, we suggest checking out Yieldstreet. It's a popular alternative asset investing platform that includes asset classes like artwork, wine, debt, real estate, and more. It also offers various funds starting at $2,500 so that you can diversify even further across several asset classes.
The bottom line
There's no denying that investing in stocks, ETFs, and fixed-income securities can build an excellent portfolio that serves you for years to come. But if you're looking to diversify and spice things up, alternative investments may deserve some room in your portfolio.
You should always understand the risks of any asset class you invest in. But when it comes to alternative investments, in particular, you may also need to be comfortable with potentially low liquidity or loss of capital. And always do your due diligence.