SoFi

Since coming on the scene in the 2010s, neobanks have challenged the traditional banking model by offering consumers tech-savvy, digital-only bank accounts, often with low (or no) fees and higher-than-average interest rates. Neobanks have also been early adopters of popular perks like early access to paychecks and fee-free overdraft protection.

But neobanks technically aren’t banks (they are financial technology companies) — they don’t typically have a bank charter permitting them, for example, to hold deposits and lend money. As a result, they don’t offer the same range of financial services you’d find at a traditional bank. And if you’re looking for a branch for in-person service, you won’t find one. Here’s a closer look at how neobanks and traditional banks compare.

What Are Neobanks?

Neobanks are financial technology (fintech) companies that offer banking services through mobile apps and online platforms. They operate entirely online and, due to reduced overhead, are generally able to offer consumers benefits like lower fees and higher interest rates on deposits.

Though they are called banks, neobanks do not have the required charters to meet the legal definition of a bank. Instead, they partner with chartered financial institutions to offer bank accounts, such as high-yield savings accounts and online checking accounts. Some also offer payment services, credit cards, and other financial services.

While neobanks offer online-only banking services, they are different from online banks. Generally, online banks have a bank charter and provide a broader range of services to their customers, including loans and investing services.

How Do Neobanks Work?

Neobanks operate by using technology to deliver banking services more efficiently and at a lower cost than traditional banks. They often enhance these services with digital features, such as real-time balance updates, spending trackers, and budgeting tools to help customers manage their finances effectively.

You can typically set up an account with a neobank by downloading an app, providing some personal information, and going through identity verification processes. Once your account is open, you manage it entirely online. Customer support is typically provided 24/7 via phone, online chat, in-app messaging, and email. Many neobanks partner with nationwide ATM networks to offer customers fee-free access to cash.

Though neobanks typically aren’t chartered, they will often partner with traditional banks to use their banking licenses, allowing them to offer insured deposit accounts and other regulated banking services. To make sure your deposits are insured by the Federal Deposit Insurance Corp. (FDIC), you’ll want to look for the FDIC logo. Keep in mind, however, that any funds you deposit in a neobank may not be protected while they are in transit to the insured bank account. The FDIC does not cover the failure or closing of a non-bank company or any money that has not been deposited in an FDIC-insured bank.

What Are Traditional Banks?

Traditional banks are established financial institutions with physical branch networks that offer a wide range of banking services. These services generally include personal and business accounts, auto loans, mortgages, credit cards, and investment products. Traditional banks offer FDIC insurance on accounts, so you can’t lose your money (up to insured limits) even if the bank were to go out of business.

Traditional banks cater to a wide range of customers, from individuals to large corporations. They often have long-standing reputations and a history of customer trust, which makes them a popular choice for many consumers who prefer in-person banking experiences or require access to specialized financial services.

How Do Traditional Banks Work?

Traditional banks operate through a network of physical branches, ATMs, and online banking platforms. Customers can visit a branch for services like opening accounts, depositing checks, applying for loans, or speaking with a financial advisor. Traditional banks also offer online and mobile banking.

In addition to providing basic banking services, traditional banks offer specialized services like wealth management, foreign currency exchange, and business loans. Banks in the U.S. are regulated on either the federal or state level, depending on how they are chartered. Some are regulated by both.

Recommended: Traditional vs. Online Banks

Neobanks vs. Traditional Banks

How Neobanks and Traditional Banks Are Different

Neobanks and traditional banks differ in several key ways, including their business models, services, and fee structures. Here are some of the main differences:

•  Physical presence: Neobanks operate exclusively online with no physical branches, while traditional banks have physical branches where customers can conduct transactions in person.

•  Fees/rates: Due to lower overhead, neobanks may often offer no- or lower-fee banking services and more competitive interest rates compared to traditional banks.

•  Range of services: Traditional banks generally provide a wider range of offerings, including business accounts, loans, mortgages, and investment products. Neobanks tend to focus on basic banking services, such as online checking accounts, savings accounts, payment services, and secured credit cards.

•  Customer service: Neobanks typically offer customer support through digital channels like chatbots and email, as well as by phone. Traditional banks offer the option of in-person customer service, which can be an advantage for those who prefer face-to-face interactions.

•  FDIC insurance: While both types of institutions may offer FDIC insurance on deposits (up to the legal limit), neobanks do not provide this protection directly.

•  Technological innovation: Neobanks often prioritize user experience and incorporate the latest fintech innovations, such as budgeting tools, spending analysis, and instant transfers. Traditional banks may lag behind in these areas due to legacy systems.

How Neobanks and Traditional Banks Are Similar

Despite their differences, neobanks and traditional banks share some common features:

•  Account types: Both neobanks and traditional banks offer basic banking services like checking and savings accounts.

•  Online and mobile banking: While neobanks operate solely online, traditional banks also offer online and mobile banking options for customers.

•  Security: Both neobanks and traditional banks typically offer state-of-the-art security technologies, including encryption, two-factor authentication, and biometrics (such as fingerprint or facial recognition).

Note: Online banks combine some of the features of traditional banks and neobanks. Like traditional banks, they may be chartered and FDIC-insured banking institutions. Similar to neobanks, they may offer tech-forward online-only banking, low/no fees, and competitive rates on deposits.

Pros and Cons of Traditional Banking for Consumers

Traditional banking offers both advantages and disadvantages. Here are some to consider.

Pros

•  Wide range of services: Traditional banks offer comprehensive financial services, including home and auto loans, credit cards, investment management services, commercial banking, and safe deposit boxes.

•  Physical branch access: Customers can visit branches for in-person assistance, which can make it easier to handle complex transactions or receive personalized advice. Branch access also offers a convenient way to make cash deposits.

•  Reputation and trust: Established banks have built customer trust over decades, providing a sense of security.

•  FDIC insurance: Federally insured banks protect your deposits up to $250,000 per depositor.

Cons

•  High fees: Traditional banks often charge fees for account maintenance, overdrafts, and other services.

•  Low returns: Traditional banks typically pay lower yields on savings and other deposit products compared to neobanks and online banks.

•  Limited technological innovation: Many traditional banks can be slow to adapt to new digital technology and may lack advanced features compared to neobanks.

•  Inconvenience of physical visits: While traditional banks offer online banking services, there may still be times when you need to visit a branch in person, which can be time consuming.

Pros and Cons of Neobanking for Consumers

Neobanking also has both benefits and drawbacks. Here’s a closer look.

Pros

•  Lower fees: Neobanks typically offer fee-free accounts or lower fees compared to traditional banks.

•  Higher APYs: Neobanks typically pay more interest on deposits compared to traditional banks.

•  User-friendly digital experience: Advanced mobile apps and digital tools provide customers with an easy, intuitive way to manage finances.

•  Convenience: Fully online banking can be a major time-saver, allowing you to avoid waiting on lines to see a teller. Many neobanks offer round-the-clock customer service.

Cons

•  Limited product range: Neobanks may not offer a full range of financial services, such as loans, mortgages, or investment products.

•  No physical branches: The lack of in-person support can be a disadvantage for customers who prefer face-to-face interactions.

•  Challenges with cash deposits: Unless the neobank is linked to ATMs that accept cash, you won’t be able to deposit cash into your account.

•  Not FDIC-insured: Neobanks are typically not chartered banks and rely on partnerships with FDIC-insured banks.

The Takeaway

Neobanks and traditional banks both offer banking services, and each has benefits and drawbacks. Neobanks can work well for those seeking a low-cost, technology-driven banking experience, while traditional banks offer more comprehensive services and the convenience of physical branches.

The right choice for you will depend on your personal preferences, financial needs, and comfort with digital banking.

SoFi holds a national banking charter, an important point to consider as you think about your banking options.

Interested in opening an online bank account? When you sign up for a SoFi Checking and Savings account with eligible direct deposit, you’ll get a competitive annual percentage yield (APY), pay zero account fees, and enjoy an array of rewards, such as access to the Allpoint Network of 55,000+ fee-free ATMs globally. Qualifying accounts can even access their paycheck up to two days early.

FAQ

How are neobanks and traditional banks different?

Neobanks are financial technology firms that offer digital banking services through apps and online platforms. They operate without physical branches and focus on low fees, streamlined services, and innovative financial tools. Neobanks are not technically banks, however, and must partner with chartered banks to offer FDIC-insured accounts.

Traditional banks have physical branches, providing in-person services alongside online banking. They are fully licensed, offer a broader range of financial products than neobanks, but tend to charge higher fees and offer lower yields on deposits.

What are the downsides of neobanks?

One potential downside of neobanks is that they’re online-only. As a result, there are no branches you can visit for in-person transactions or assistance. Neobanks also have a narrower range of financial products and services compared to traditional banks. In addition, neobanks technically aren’t banks and must partner with chartered and licensed institutions to offer Federal Deposit Insurance Corporation (FDIC) insurance.

What are some advantages of neobanks?

Neobanks offer a number of advantages, including competitive interest rates on deposits, low (or no) account fees, and 24/7 customer service. Many also offer in-app perks like real-time spending notifications and user-friendly budgeting tools.

Photo credit: iStock/MicroStockHub

SoFi Checking and Savings is offered through SoFi Bank, N.A. Member FDIC. The SoFi® Bank Debit Mastercard® is issued by SoFi Bank, N.A., pursuant to license by Mastercard International Incorporated and can be used everywhere Mastercard is accepted. Mastercard is a registered trademark, and the circles design is a trademark of Mastercard International Incorporated.

Annual percentage yield (APY) is variable and subject to change at any time. Rates are current as of 12/23/25. There is no minimum balance requirement. Fees may reduce earnings. Additional rates and information can be found at https://www.sofi.com/legal/banking-rate-sheet

Eligible Direct Deposit means a recurring deposit of regular income to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government benefit payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Eligible Direct Deposit”) via the Automated Clearing House (“ACH”) Network every 31 calendar days.

Although we do our best to recognize all Eligible Direct Deposits, a small number of employers, payroll providers, benefits providers, or government agencies do not designate payments as direct deposit. To ensure you're earning the APY for account holders with Eligible Direct Deposit, we encourage you to check your APY Details page the day after your Eligible Direct Deposit posts to your SoFi account. If your APY is not showing as the APY for account holders with Eligible Direct Deposit, contact us at 855-456-7634 with the details of your Eligible Direct Deposit. As long as SoFi Bank can validate those details, you will start earning the APY for account holders with Eligible Direct Deposit from the date you contact SoFi for the next 31 calendar days. You will also be eligible for the APY for account holders with Eligible Direct Deposit on future Eligible Direct Deposits, as long as SoFi Bank can validate them.

Deposits that are not from an employer, payroll, or benefits provider or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, Wise, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, or are non-recurring in nature (e.g., IRS tax refunds), do not constitute Eligible Direct Deposit activity. There is no minimum Eligible Direct Deposit amount required to qualify for the stated interest rate. SoFi Bank shall, in its sole discretion, assess each account holder's Eligible Direct Deposit activity to determine the applicability of rates and may request additional documentation for verification of eligibility.

See additional details at https://www.sofi.com/legal/banking-rate-sheet.
*Awards or rankings from NerdWallet are not indicative of future success or results. This award and its ratings are independently determined and awarded by their respective publications.

External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.
This content is provided for informational and educational purposes only and should not be construed as financial advice.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

SOBK0523012

A suspicious activity report, or SAR, is a document that financial institutions must submit to the federal government when they detect unusual and suspicious activities. SARs serve as an early warning system for the authorities, helping law enforcement detect, investigate, and prevent financial crimes like money laundering, fraud, and terrorist financing.

Here’s a closer look at what a SAR is and what type of financial activity triggers a suspicious activity report.

What Is a SAR?

A SAR, or suspicious activity report, is the standard document that banks and some other businesses must file with the Financial Crimes Enforcement Network (FinCEN) if they detect unusual behavior by an individual or organization. These reports are housed in a central government database and are designed to pick up illegal activities, such as money laundering, tax evasion, criminal financing, or other types of fraud that would not be flagged under other reports.

SAR filings can be triggered by any type of financial transaction that is out of the ordinary, such as large cash deposits or withdrawals into bank accounts, frequent wire transfers to countries known for criminal activity, structuring transactions to avoid reporting requirements, and any transaction that doesn’t seem to have a legitimate business purpose.

A suspicious activity report will contain details about the suspect transaction, the parties involved, and the reasons why the transaction is considered suspicious. The financial institution is not required to provide proof that a crime has occurred, nor is the institution’s client notified that a SAR related to their account has been filed.

The data contained in SARs is made available to multiple law enforcement agencies and is often combined with other information to build cases and prevent financial crimes.

Who Regulates SARs?

In the United States, the Financial Crimes Enforcement Network (FinCEN), a bureau of the U.S. Department of the Treasury, regulates SARs.

Under the Bank Secrecy Act (BSA) of 1970, banks and other financial institutions must file SARs with FinCEN to help government agencies detect and prevent money laundering and other financial crimes. Traditionally, this meant filing a paper report, but starting in 2013, FinCEN moved its reports entirely online. Businesses and individuals now use the BSA E-Filing System to submit a SAR.

FinCEN sets the rules and guidelines that determine when a SAR should be filed, what information should be included, and how financial institutions should handle suspicious transactions.

Who Can Make SARs?

Generally, financial institutions and businesses engaged in financial services are required to make SARs. This includes banks, credit unions, stock/mutual fund brokers, and different kinds of money service businesses (such as check-cashing companies and money order providers). Other types of businesses that must submit SARs include:

•  Casinos

•  Precious metals and gems dealers

•  Insurance companies

•  Mortgage companies

Essentially, if there is an opportunity to launder money or commit any other type of financial crime, a business or organization (and its employees) are required to be aware of the rules and requirements of SARs.

Who Do SARs Alert?

A suspicious activity report often begins when an employee of a financial institution notices an unusual activity, such as large sums of money being deposited into an account that had never been used for that kind of activity, or an anonymous wire transfer of funds out of the country. The individual would then communicate their observation to a supervisor, who files a SAR.

When a SAR is filed, it goes to the Financial Crimes Enforcement Network, or FinCEN. This regulatory body is in charge of analyzing SARs and providing the resulting intelligence to law enforcement agencies, including the Federal Bureau of Investigation (FBI) and Drug Enforcement Administration (DEA). The information from SARs helps these agencies detect patterns of illegal activity and investigate cases that could otherwise go unnoticed.

Recommended: How Do Banks Investigate Unauthorized Transactions?

What Triggers SARs?

A variety of situations can trigger the filing of a SAR. These scenarios typically involve activities that seem unusual, inconsistent with normal financial behavior, or indicative of illegal conduct. Here are some common triggers:

Large Cash Transactions

Unusually large cash deposits or withdrawals, especially when they are inconsistent with a customer’s usual banking patterns, can trigger a SAR. Financial institutions are required to report cash transactions exceeding $10,000 per day.

Unusual Account Activity

If there is sudden or unusual account activity, such as rapid transfers between accounts or sudden high-value transactions without an apparent legitimate purpose, a SAR may be filed. This type of activity could suggest money laundering, tax evasion, or fraud.

Recommended: Understanding Savings Account Withdrawal Limits

Structuring Transactions

Structuring occurs when an individual deliberately breaks up large amounts of money into smaller transactions to evade reporting requirements. This is a common tactic used in money laundering and can trigger the filing of a SAR.

Suspicious Wire Transfers

An unusually large number of wire transfers; wire transfers that fall into certain repeated patterns; and wire transfers to or from countries known for financial crime (such as tax evasion or terrorism) can trigger a SAR.

Unexplained Wealth

If a customer suddenly deposits large sums of money into a checking or savings account, or purchases expensive assets without a clear, legitimate source of funds, a SAR may be triggered. This could be seen as a sign of illicit activity, such as drug trafficking, corruption, or fraud.

Transactions Involving Shell Companies

The use of shell companies to conduct financial transactions can be considered suspicious. Shell companies often lack significant assets or operations and may be used to conceal the true nature of financial dealings, prompting a SAR filing.

What Happens When a SAR Is Triggered?

If your financial institution files a SAR due to any of your banking transactions, nothing would happen right away. And since banks are not allowed to disclose a SAR to customers, you would not even be aware of it.

Typically, If there’s no illegal activity involved, FinCEN will not pursue the issue and it will not have any negative impacts on your life. Banks routinely file SARs to avoid being cited for violating their legal responsibilities and many do not lead to adverse consequences. However, if a SAR is suspicious enough, it may gain the attention of federal law enforcement authorities.

If, after conducting an investigation, the government believes illegal activity occurred, it could potentially seek a court order to temporarily freeze your bank account. This is done to keep the funds in question from being withdrawn until the investigation is completed.

Why Suspicious Activity Reports Are Important

SARs play a vital role in combating financial crime. They provide a way for financial institutions to alert regulators to potential illegal activities, giving them an opportunity to investigate and take action before criminal activities escalate. SARs help prevent money laundering, terrorist financing, drug trafficking, tax evasion, and other serious crimes.

SARs also contribute to global efforts to combat financial crime, since the intelligence is often shared across borders. International cooperation is often crucial for investigating and prosecuting transnational criminal organizations, making SARs a valuable tool in global anti-money laundering efforts.

Recommended: Guide to Keeping Your Bank Account Safe Online

Are SARs Confidential?

Yes, SARs are confidential, and strict rules govern how they are handled. The person or organization that files a SAR is prohibited from disclosing the report’s existence or the fact that it has been filed. This confidentiality is crucial to ensure that the subject of the SAR is unaware of the investigation, thereby preventing them from altering their behavior, destroying evidence to cover their tracks, or fleeing.

Violating SAR confidentiality is a serious offense and can lead to legal penalties for the individual or institution responsible. The only parties allowed to know about the SAR are the regulatory authorities and law enforcement agencies involved in investigating the suspicious activity.

Recommended: How to Make Money Fast

The Takeaway

Suspicious activity reports (SARs) are essential tools for detecting and preventing financial crime. These reports enable financial institutions to alert authorities when they encounter transactions that raise red flags for illegal activities such as money laundering, fraud, or terrorist financing.

However, SARs are commonly filed and, in many cases, do not lead to further investigation. As long as you’re not engaging in any illegal financial activities, a SAR should not have any impact on your life or cause any interruptions in your ability to use your checking or savings account.

Interested in opening an online bank account? When you sign up for a SoFi Checking and Savings account with eligible direct deposit, you’ll get a competitive annual percentage yield (APY), pay zero account fees, and enjoy an array of rewards, such as access to the Allpoint Network of 55,000+ fee-free ATMs globally. Qualifying accounts can even access their paycheck up to two days early.

FAQ

What triggers a suspicious activity report?

A suspicious activity report (SAR) is triggered when a financial institution detects unusual or potentially illegal activity. This can include large cash transactions, sudden changes in account usage, wire transfers to countries known for criminal activity, and structuring transactions (i.e., breaking up large amounts into smaller transactions to evade reporting requirements). The goal is to help government authorities detect and investigate crimes like money laundering, tax evasion, fraud, and terrorist financing.

What happens when you get a SAR?

If a bank or company submits a SAR about you, it is submitted to the Financial Crimes Enforcement Network (FinCEN). The report remains confidential, and you will not be informed. FinCEN reviews the SAR and may share it with law enforcement agencies for further investigation. Not all SARs lead to further investigation, however. A large number are simply routine and don’t lead to any adverse consequences.

What are examples of suspicious activity for SARs?

Examples of suspicious activity that can trigger a SAR include:

•  Large or unusual cash deposits or withdrawals

•  Transactions that seem unusual for the stated business type

•  Transactions inconsistent with a customer’s profile

•  Frequent international wire transfers to high-risk jurisdictions

•  Structuring transactions to avoid reporting thresholds

•  Use of shell companies for significant financial transactions

•  Sudden large asset purchases without a clear source of funds

Photo credit: iStock/Zorica Nastasic

SoFi Checking and Savings is offered through SoFi Bank, N.A. Member FDIC. The SoFi® Bank Debit Mastercard® is issued by SoFi Bank, N.A., pursuant to license by Mastercard International Incorporated and can be used everywhere Mastercard is accepted. Mastercard is a registered trademark, and the circles design is a trademark of Mastercard International Incorporated.

Annual percentage yield (APY) is variable and subject to change at any time. Rates are current as of 12/23/25. There is no minimum balance requirement. Fees may reduce earnings. Additional rates and information can be found at https://www.sofi.com/legal/banking-rate-sheet

Eligible Direct Deposit means a recurring deposit of regular income to an account holder’s SoFi Checking or Savings account, including payroll, pension, or government benefit payments (e.g., Social Security), made by the account holder’s employer, payroll or benefits provider or government agency (“Eligible Direct Deposit”) via the Automated Clearing House (“ACH”) Network every 31 calendar days.

Although we do our best to recognize all Eligible Direct Deposits, a small number of employers, payroll providers, benefits providers, or government agencies do not designate payments as direct deposit. To ensure you're earning the APY for account holders with Eligible Direct Deposit, we encourage you to check your APY Details page the day after your Eligible Direct Deposit posts to your SoFi account. If your APY is not showing as the APY for account holders with Eligible Direct Deposit, contact us at 855-456-7634 with the details of your Eligible Direct Deposit. As long as SoFi Bank can validate those details, you will start earning the APY for account holders with Eligible Direct Deposit from the date you contact SoFi for the next 31 calendar days. You will also be eligible for the APY for account holders with Eligible Direct Deposit on future Eligible Direct Deposits, as long as SoFi Bank can validate them.

Deposits that are not from an employer, payroll, or benefits provider or government agency, including but not limited to check deposits, peer-to-peer transfers (e.g., transfers from PayPal, Venmo, Wise, etc.), merchant transactions (e.g., transactions from PayPal, Stripe, Square, etc.), and bank ACH funds transfers and wire transfers from external accounts, or are non-recurring in nature (e.g., IRS tax refunds), do not constitute Eligible Direct Deposit activity. There is no minimum Eligible Direct Deposit amount required to qualify for the stated interest rate. SoFi Bank shall, in its sole discretion, assess each account holder's Eligible Direct Deposit activity to determine the applicability of rates and may request additional documentation for verification of eligibility.

See additional details at https://www.sofi.com/legal/banking-rate-sheet.
*Awards or rankings from NerdWallet are not indicative of future success or results. This award and its ratings are independently determined and awarded by their respective publications.

External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.
This content is provided for informational and educational purposes only and should not be construed as financial advice.

Financial Tips & Strategies: The tips provided on this website are of a general nature and do not take into account your specific objectives, financial situation, and needs. You should always consider their appropriateness given your own circumstances.

SOBK0523009

As alternative investments have become more accessible for all investors, it’s essential to weigh the pros and cons of these assets: on the one hand, alts offer the potential for diversification and higher returns — but they’re often higher cost, illiquid, and subject to complex tax treatment.

Understanding the advantages and disadvantages of these assets is especially crucial right now, because alts used to be the province of high net-worth and accredited investors. Now, however, alts are accessible to individual (retail) investors via conventional instruments like mutual funds and ETFs, as well as some retirement accounts like certain types of IRAs.

Recommended: What Are Alternative Investments?

Pros of Investing in Alts

There are a number of reasons why investors may find alternative investments attractive.

Diversification

Whereas traditional investments tend to move in tandem with the markets, this makes them vulnerable to market volatility, and increases risk exposure. But because most alternative investments have a low correlation with stock and bond markets, they generally move independently, and can thus provide a buffer against risk.

Investing in alts therefore can provide portfolio diversification, which may also help improve risk-adjusted returns over time.

Potential for Higher Returns

There are a couple of reasons why some alts may deliver higher portfolio returns. The first relates to the factors above. Because alternative investments have a low correlation with other assets and provide diversification (and a hedge against inflation or interest rates), this can improve a portfolio’s risk-adjusted returns.

The second is that some alts — e.g. hedge funds, private equity, venture capital, derivatives trading — employ high-risk strategies like short selling, various types of options trading, and leverage (among others), that may deliver higher returns.

Keep in mind that pursuing above-average returns almost always means a much higher risk exposure.

Potential for Passive Income

Some alternatives, like real estate, not only offer the potential for gains but the possibility of passive income as well. For example, real estate investment trusts (REITs) are required to distribute at least 90% of the fund’s income to shareholders.

In addition, certain types of alts (for example, some private equity stocks and funds that invest in these) may also pay dividends, which can also enhance income.

Hedge Against Inflation

Similarly, investing in alternative assets like real estate or commodities (e.g precious metals) can, in some cases, provide a hedge against inflation. That’s because tangible alts may increase in value during inflationary periods versus more traditional asset classes, which may see their value eroded by inflation.

By the same token, some alts can provide a hedge against interest rate risk, again because they have a low correlation with the asset classes that suffer in periods of rising rates.

The challenge here for investors is that both interest rates and inflation can be unpredictable, and using certain assets as a hedge is no guarantee of success.

Recommended: 2023 Capital Gains Tax Guide

Alts Are Available Through ETFs and Mutual Funds

As noted above, a shift has occurred in recent years, allowing individual investors to access different alternative asset classes within traditional fund structures like ETFs and mutual funds.

This is one way that retail investors can gain access to this class of assets that once was limited to high net-worth and accredited investors.

The relative accessibility of publicly traded funds can allow individuals to invest in different alternative sectors — e.g. private equity, private credit, real estate, currencies (including digital currencies) — through these vehicles.

That said, although a mutual fund is a type of pooled investment fund, that doesn’t eliminate all the risk factors that can come with investing in alts.

Accessible via Retirement Accounts

Related to the above, another advantage to investing in alts for individual investors is that it’s possible in some cases to add alts to your IRA. While most mainstream or discount brokers don’t yet offer this option, it’s possible to find asset managers that do.

It bears repeating, though, that retirement funds are meant for the long term, and it’s wise to carefully vet all investment choices in order to limit losses.

Personal Appeal

Some alternatives, such as collectibles (e.g. wine, art, memorabilia, antiques, classic cars) offer the additional gratification of fulfilling an investor’s passion or hobby.

💡 Quick Tip: All investments come with some degree of risk — and some are riskier than others. Before investing online, decide on your investment goals and how much risk you want to take.

Cons of Investing in Alts

Alternative investments, which fall outside the realm of conventional securities and strategies, by their nature come with a few disadvantages investors must keep in mind.

Low Liquidity/Redemption Issues

Alternative investments are notoriously illiquid. That means that they aren’t traded frequently, and the markets for these assets can be smaller with lower trading volume.

For example, some collectibles also come with a high degree of risk because a car, case of wine, set of sports cards, could become worthless if there is a shift in taste or trends. These types of tangible or physical investments — including certain types of real estate and commodities — are also more vulnerable to environmental factors (fire, flood, weather, deterioration) that can instantly erode the asset’s value.

High-Risk Strategies

In the quest for higher returns, many alternative asset classes use high-risk strategies that include the risk of total loss. Trading futures, options, and other derivatives, for example, can be highly risky, especially for less experienced investors.

The same is true of certain vehicles, like investing in hedge funds (which also come with high fees) which employ a high degree of leverage, or venture capital, where an investment in a particular venture can go south.

Recommended: What Are Liquid Assets?

Complex Tax Treatment

Some alts may offer certain tax advantages. However, alts can be taxed in different ways, and don’t necessarily lower your investment taxes.

Most investment gains are taxed according to capital gains tax rules, but that isn’t always true of alternative investments when purchased directly, or when investing in a fund. It might be wise to consult a tax professional.

Higher Costs

Some alts come with a higher barrier to entry in terms of investment fees, management fees, and other charges that are not as common with conventional securities.

Hedge funds, for example, typically have a very high minimum investment requirement, often in the six or seven figures, in addition to management and performance fees that can hit 20%.

Lack of Transparency and Publicly Available Data

One of the most troubling aspects of alternative investments is that there is very little transparency around how these assets are traded, their historical price data, and so on.

This can make it difficult to conduct certain types of technical or fundamental analysis, as you might with stocks, in order to gauge the real-time value of a certain asset, never mind its long-term potential.

The Takeaway

As investors’ interest in branching out beyond the traditional asset classes continues to grow, alternative investments may continue to spark new interest among individuals, especially as the availability of alts expands into new vehicles, like conventional mutual funds, ETFs, and even retirement accounts.

Understandably, investors are often on a quest to find the next new thing that will help tamp down risk and improve returns. But alts do come with some notable risk factors that investors must take into account before embarking on any new strategies.

Invest in what matters most to you with SoFi Active Invest. In a self-directed account provided by SoFi Securities, you can trade stocks, exchange-traded funds (ETFs), mutual funds, alternative funds, options, and more — all while paying $0 commission on every trade. Other fees may apply. Whether you want to trade after-hours or manage your portfolio using real-time stock insights and analyst ratings, you can invest your way in SoFi's easy-to-use mobile app.

Photo credit: iStock/cagkansayin