Comparing traditional vs. alternative investments makes it sound like you must choose one type. In reality, you don’t – each presents distinct advantages and disadvantages you can weigh based on your investment strategies, goals and risk tolerance.
Even so, this overview of the differences regarding traditional vs. alternative investments can help you decide how either or both types of investments might fit into your financial goals.
What Are Traditional Investments?
Traditional investments are well-established financial instruments, such as stocks, bonds and cash equivalents. Stocks are shares of ownership in a company, while bonds represent loans investors make to governments or businesses for a payback with interest. Cash equivalents can include Treasury bills.
Traditional investments are traded on public markets, such as stock exchanges and are heavily regulated, making them liquid and offering some protections.
What Are Alternative Investments?
Alternative investments are a broad group of assets that don’t fit into the standard asset classes of stocks, bonds or cash equivalents and aren’t traded on public exchanges.
Alternative assets can be classified into several main types, such as real estate, art, collectibles and gold. They can also include other commodities, such as private equity and hedge funds.
Investments in alternative assets are growing as alternative investment products become more accessible to retail investors. Investors generally invest in alternative assets to diversify their portfolios and reduce risk.
Difference Between Traditional and Alternative Investments
Along with where and how you might invest in traditional vs. alternative investments, several other factors distinguish these two investments. For example, they have different return and risk profiles, mostly lack correlation and diverge in terms of market availability, ownership and control.
Return Profiles
When considering traditional vs. alternative investments, it’s wise to consider their respective return profiles. Stocks have performed well over the long term, offering savvy investors a solid return. However, they’ve been known to experience losses, too. You can expect to see lower returns from bonds and cash equivalents.
Alternative investing can offer higher returns than stocks, bonds and cash equivalents, but those potential returns come with increased risk and concerns about liquidity or the ability to quickly turn assets into cash. For example, real estate can provide strong returns but can also be sensitive to economic factors like market downturns.
Similarly, an alternative investment like venture capital (VC), which involves investing in startups and budding businesses, has a volatile return profile – some VCs can have large returns. In contrast, others may see lower returns or even losses.
Risk
All investments come with some level of risk, which can vary even within asset classes. While stocks have historically performed well, they can also be volatile, delivering lower-than-expected returns or losses. By comparison, bonds and cash equivalents tend to be less volatile, though with lower average returns.
As a class, alternative investments tend to be higher risk than traditional investments, which is why alternative investments present the possibility of higher returns.
Generally, real estate carries higher risks than stocks and bonds. However, this risk depends on the property and investment strategy, along with other factors. For venture capital, while the risks are high, they can be even more stratified depending on the stage of the supported company.
Diversification
Diversifying your investment portfolio can help prevent one asset or asset class from sinking your investments. Alternative investments are a particularly useful class of assets that can help reduce the overall risk of your portfolio and stabilize returns during periods of market volatility.
In general, alternative investments have a low correlation to financial instruments sold on the markets, such as stocks. A mix of asset classes can diversify your portfolio; a mix that includes alternative assets can further reduce your exposure to market declines and enhance the overall performance of investment accounts.
Liquidity
Liquidity or the ability to convert an asset to cash is another area where traditional and alternative investments differ.
Traditional investment assets, such as stocks and bonds, are highly liquid. Both can be sold on public market exchanges quickly and easily to generate cash, giving investors in stocks and bonds a great deal of flexibility in adjusting their investment portfolios.
Alternative investments, on the other hand, are less liquid and typically require longer holding periods before an investor can sell an asset. With real estate, for example, it can take an average of 60–90 days to sell a residential property and six months to a year to unload a commercial property.
If you consider VC, the timeline grows even longer. On average, you can expect your money to be tied up in a startup for at least five to 10 years.
Ownership and Control
The aspects of ownership and control provide some of the deepest contrasts between the two investment types.
When you purchase stocks and bonds, you get a share of a company or an interest in the outcome of a company or project. As a stockholder, your degree of ownership is often small. As a bondholder, it’s nonexistent. This severely limits your influence and control.
With many alternative assets, you’ll own a tangible asset, such as a gold bar or fine art, giving you full control.
As an investor in private equity or real estate, you can also immediately enjoy a more active role. That involvement can help you become more strategic in your decision-making and have a greater influence over the outcome of your investments.
Traditional vs. Alternative Investments: Which Is Right for You?
Examining the differences between traditional and alternative investments seems to set you up to choose between them. Ultimately, however, how you invest is less about the differences between the two types of investments than your investment strategies and goals.
Investing in traditional assets like stocks and bonds can help lay a sound foundation for your investment portfolio. Adding alternative assets selectively and strategically can diversify your portfolio while reducing your overall risk and presenting the potential for high returns.
Rather than choose between the two investment types, why not use both? It’s a true win-win – something exceedingly rare in the investment world.
Frequently Asked Questions
What is considered a traditional investment?
A traditional investment is a well-known asset, such as a stock, bond or cash equivalent, traded on a public market like a stock exchange. Traditional investments have established markets, which offer the benefit of historical data and are regulated, which ensures transparency and protection for investors.
What is an example of an alternative investment?
An alternative investment is any investment opportunity in which you put your money into something other than stocks, bonds or cash equivalents. For example, you might buy a house to lease it to tenants to earn rental income or purchase a work by an up-and-coming artist hoping it will appreciate.
What is the definition of alternative investments in finance?
Alternative investments refer to a category of assets that fall outside the traditional asset classes of stocks, bonds and cash. Examples of alternative investments include private equity, venture capital, hedge funds, real estate and commodities, which are typically illiquid and can diversify your portfolio.