What are Alternative Investments?

You might consider alternative investments if you’re looking to invest in something other than stocks and bonds. But what are alternative investments? This broad class of assets falls outside the traditional investments of stocks, bonds and cash, offering you different risk and return profiles. 

Alternative assets – real estate, precious metals, oil and natural gas, hedge funds and more – can diversify your investment portfolio. Investing in these nontraditional assets was once thought to be the domain of high-net-worth and institutional investors, but in recent years, average retail investors have found investment opportunities. 

Learning more about this wide range of assets can answer your question, “What are alternative investments?” and help you decide whether alternative investing fits your investment strategies and goals.

Difference Between Alternative and Traditional Investments

So, what are alternative investments and how do they differ from traditional investments?

Stocks, bonds and cash equivalents are conventional, well-established financial instruments grouped as traditional investments. Other instruments, such as mutual funds and exchange-traded funds, can be added to those longtime traditional investments.

Traditional investments can be readily bought and sold on public market exchanges. These assets benefit from the availability of lots of historical data and regulatory oversight, providing investors with more transparency and safeguards.

By contrast, alternative investments include assets other than stocks, bonds or cash equivalents and they have little to no correlation with traditional investment markets. 

The broad alternative investment tent includes real estate, commodities, private equity, hedge funds, private debt, collectibles, cryptocurrencies and digital assets.

The lack of correlation to traditional assets and alternative investments' higher risk and return profile can diversify your investment portfolio. Generally, alternative assets can mitigate the volatility of traditional assets, help manage risk, hedge against inflation and potentially enhance returns.

Types of Alternative Investments

Understanding the benefits of alternative investments, you might not wonder whether you should invest in alternative assets, but instead, how to invest in alternatives. Here are different types of alternative investments you can make.

Real Estate

Investing in real estate can involve buying residential or commercial properties or raw land. You can also invest in real estate investment trusts (REITs), mutual funds or crowdfunding. 

While you have the potential to generate passive income from the rents of residential or commercial properties, REITs allow you to earn a dividend without concerns about physically owning or maintaining property. Real estate is among the best alternative investments for the average retail investor.

Commodities

Commodities are raw materials used to make other goods and services. Examples include oil, natural gas, gold, silver, wheat, corn, cattle and more. Commodities are categorized as hard – energy and metals – and soft – agricultural products. 

Commodities can be bought and sold on public marketplaces, such as the Chicago Mercantile Exchange, the New York Mercantile Exchange and the London Metal Exchange. 

Commodities are an important part of the global economy. They feed people and livestock and fuel manufacturing. Production levels and consumer and business demand affect their values.

Private Equity

With private equity, you are investing in companies. However, the companies aren’t listed on public exchanges and you’re not buying stock. You’re buying out a business, supplying capital for growth or providing venture capital for startups. These investments are considered high-risk and high-reward.

Hedge Funds

Hedge funds are complex investments with potential for high returns but at significant risks. Like in mutual funds, investors pool their money in hedge funds. 

However, professionals actively manage hedge funds and generally involve complex, high-risk investment strategies. Hedge funds, such as pension funds and endowments, are available only to high-net-worth individuals and institutional investors.

Private Debt

Investors in private debt provide loans or credits to small or emerging private companies, ones not publicly traded. Private debt can offer regular income – with higher yields than fixed-income investments – and diversify your portfolio, but it also comes with high risks and illiquidity.

Collectibles

From art masterpieces to sports memorabilia, collectibles can be an interesting path to investing because of your passion and interest in a field. You must consider the cost and time of this alternative investment, including that your collectible won’t generate any income until it is sold. 

The value of collectibles is influenced by rarity, condition, age, provenance (its history), authenticity, design, quality and market.

Cryptocurrencies

Cryptocurrencies are a relatively new asset, rising in popularity over the last 15 years. Lacking backing from a government or central bank, cryptocurrencies can be highly volatile, making them less attractive to investors with an aversion to risk. 

However, you also have the potential for high returns and passive income from staking and lending. Their values can be driven by supply and demand, how well they are adopted, regulations and technology.

Digital Assets

Digital assets differentiate traditional investments to another level. They are virtual and supported only by a decentralized ledger, known as blockchain – the technology that powers cryptocurrencies. 

A digital asset can generate a yield, be used as a medium of exchange, store value and provide proof of value. 

Without a standard classification system, digital assets include cryptocurrency, tokenized money and other tokenized assets (digitized, real-world assets), known as non-fungible tokens or NFTs, which provide proof of ownership.

Pros and Cons of Alternative Investments

Alternative investments can diversify your portfolio and potentially generate higher returns than traditional investments. Those benefits also come with higher risks. Consider these pros and cons of investing in alternative assets.

Pros

• Diversification
• Potential for higher returns
• Unique investing opportunities
• Inflation hedge
• Reduced volatility

Cons

• Higher-risk assets
• Lack of transparency and oversight
• Lack of liquidity
• Higher fees

Use Alternative Investments to Build Diversity into Your Portfolio

Alternative investments are a broad grouping of assets that aren’t traditional investments like stocks, bonds or cash. Adding alternative assets, such as real estate, private equity, cryptocurrencies or collectibles to your investments can diversify your portfolio to mitigate the volatility of traditional markets and hedge against inflation. 

Alternative investments have a higher risk and return profile, potentially boosting your returns. With a better understanding of alternative investments, you can consider whether these nontraditional assets fit your investment strategy and goals.

Frequently Asked Questions