Table of Contents
What are alternative investments?
7 types of alternative investments
How are alternative investments regulated?
Potential benefits and risks of alternative investments
What to consider before making alternative investments
The bottom line
Oct 18, 2022
6 min read
Learn how investors can use various asset classes to diversify their portfolios and take advantage of less common, but potentially profitable, opportunities.
Many new investors start with the basics: buying publicly traded stocks and bonds, or holding cash in savings accounts. They may also purchase mutual funds or exchange-traded funds (ETFs), though these funds are often made up of these securities as well. Investors who are looking for other ways to earn returns on their money can turn to alternative investments in addition to—or instead of—the standard options.
Alternative investments are investment types that don’t fall within the traditional asset classes of stocks, bonds, or cash. They can encompass a wide range of investments and are generally a little more difficult to buy or sell because of regulatory restrictions, their cost, or limited availability. Still, understanding and potentially purchasing alternative investments could be a way to build a diversified portfolio.
Alternative investments can include specific types of assets, along with investment strategies that take a non-traditional approach. Some popular options include:
are digital assets that may function similar to a commodity, currency, or stock. Although Bitcoin and Ethereum are two of the best known cryptos, there are thousands of others, known as alt coins. Cryptos have also become a mainstream investment for everyday investors. Morning Consult, a business intelligence company, found that slightly more U.S. adults own crypto than a certificate of deposit (CD), a type of savings account.
One relatively common type of alternative investment is real estate. Some people own and rent out homes, apartments, or storefronts to generate income. Investors can also invest in residential or commercial real estate in indirect ways, such as by purchasing shares in a real estate investment trust (REIT), which can either be private or trade on a stock exchange.
Collectibles can include various physical and digital products that may increase in value over time. Investors can buy and store rare coins, stamps, trading cards, antiques, art, and wine as a potential way to make money.
can include natural resources, farmland, and forests. Investors may purchase natural resources such as oil, corn, gold, usually by using futures, options, or swaps—securities based on the value of other securities or assets—rather than purchasing and holding the physical commodities. Investments in farmland and forests are a bit different because they can be long-term investments that provide an income stream to investors.
Unlike with public companies, investors can’t simply buy and sell stock in a private business. However, people can invest in private businesses in other ways, like angel investing. These investments may be riskier than purchasing shares in a large and stable public company that must abide by regulations and rules of disclosure. But they may also lead to big returns if the company prospers.
Some investors lend to businesses and make money on the interest payments. Large institutional investors may put money into private credit funds that make various types of business loans, including risky ones with high interest rates to companies that are in bad shape and can’t get financing from banks. Individual investors may be able to make loans through crowdfunding or peer-to-peer loan marketplaces, or buy buying into a fund that offers private credit.
are a type of alternative investment that invest money on behalf of wealthy individuals and institutions in exchange for a fee and a cut of the profits. Professional investors develop and implement various strategies, and different hedge funds may have different goals or approaches.
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There’s no single approach to regulating alternative investments because they include a wide variety of assets that may fall under different regulators’ purview.
For example, the Commodity Futures Trading Commission (CFTC) regulates the sale of commodities and related futures, options, and swaps, while the Securities and Exchange Commission (SEC) helps oversee federal securities laws and investments in securities.
Sometimes, this makes for clear and straightforward regulations. For instance, companies that want to sell securities, such as stock, to investors must register with the SEC when they do an initial public offering or a secondary offering. Registering requires detailed financial disclosures and reporting on the company’s business.
Other companies, usually those that are private, can get exemptions for these requirements in several ways. One way is by selling investments to accredited investors—wealthy or knowledgeable investors who may be better suited to investing in private companies that haven’t disclosed as much information as public companies.
However, regulations and protections on alternative investments aren’t always clear, or even exist. Some collectibles, such as trading cards, aren’t regulated by federal authorities and it’s up to marketplaces and individuals to create and enforce rules. Or, with new investments, like cryptocurrencies, there are still unanswered questions about how cryptos are classified (as a commodity or security) and which regulations apply.
Regardless of the formal regulations, investors need to be conscious of scams. Because fraudsters are already acting illegally, they may also falsely claim to be complying with the law and/or offer guaranteed returns.
As with any type of investment, there are potential benefits and risks to alternative investments.
Alternative investing may help diversify a portfolio by introducing assets that don’t closely correlate with the rise and fall of stock or bond prices.
While there are no guarantees, some alternative investments may offer large returns or a steady income stream.
Investors who have particular knowledge in a subject, such as wine or their local real estate market, may be able to use alternative investments to profit from that knowledge.
Some alternative assets may be complex and difficult to understand, which could make it harder to detect a scam or understand the related risks.
Alternative assets may be subject to fewer (or no) regulations compared to traditional assets. The lack of consumer protections and regulations could make them a riskier option for less sophisticated investors.
Because it can be more difficult to buy and sell alternative investments, market makers and investment advisors may charge higher fees than on traditional investments. In turn, these can eat into investors’ overall returns.
The minimum investment required to get into the public market can be as low as the price of a single share of stock. Alternative investments may require more money—for example, to invest in real property, you might need tens of thousands of dollars for a down payment.
Investors may want to ask themselves a few questions before putting their money on the line with an alternative investment:
Additional questions and due diligence may be warranted depending on the asset type, specific investment, and investor’s experience in the market.
While many people think of publicly traded stocks, bonds, and savings when investing, these traditional investments aren’t the only options. Alternative investments include both long-trusted and brand-new options, such as real estate and cryptos. Investors can use these various asset classes to diversify their portfolios and take advantage of less common, but potentially profitable, opportunities.
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