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A Guide to Alternative Investments

November 23, 2020 · 7 minute read

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A Guide to Alternative Investments

Usually when people talk about investing they are referring to assets such as stocks or bonds. While these are good investments for building a diversified portfolio, there are many other different types of investments to consider as well. An alternative investment is an asset that isn’t included in a 401(k) account or traded on the public stock market. Common alternative investments include gold, art, and real estate.

Investors frequently include alternative investments in their portfolio to increase diversification and reduce risk. Alternative investments are generally not strongly correlated with the stock market, and may even be negatively correlated, so by holding them investors can reduce their risk of losses during economic downturns and potentially create more opportunities for growth.

Let’s look into some popular alternative investment options, their potential benefits and downsides.

Types of Alternative Investments

There are many types of alternative investments, from more traditional options to some truly surprising ones! The following is not a full list of alternative investment options, but some of the more common options.

Real Estate

This could include owning a home, owning a rental property, flipping a house, investing in commercial real estate, industrial real estate, or other options. Investors can also buy into Real Estate Investment Trusts, or REITs. The reason real estate is so valuable is that there is only so much of it available on the planet. Investing in real estate requires some knowledge, skill, and luck, but this popular alternative investment generally does well in all economic cycles.

Precious Metals

Precious metals such as gold and silver are popular alternative investments. They are considered a safe store of value and a good hedge against inflation, they’re highly liquid, and they don’t tend to have the volatility of the stock market. Investors can buy precious metals directly online or through exchange-traded funds (ETFs) and mining stocks.

Commodities

Individuals can invest in natural resources, including agriculture, metal, and energy. This includes raw materials such as coffee, sugar, beef, and corn. Generally, investors purchase commodities using futures contracts or ETFs.

Tax Liens

When property owners can’t pay property taxes and default on their loans, some municipal governments sell tax liens in auctions. This allows them to collect the taxes owed plus additional interest. Investors can purchase these tax liens and earn income from them or even end up owning the foreclosed home.

Equity Crowdfunding

Investors can buy a slice of startup companies through equity crowdfunding platforms such as AngelList and SeedInvest. This differs from traditional crowdfunding in that investors actually own equity in the company. This is considered a risky investment, because if the startup fails, investors may lose all of their money. On the other hand, if a startup does well, investors can see significant gains.

Art

Investing in art has traditionally been something only available to high net worth individuals, but there are some new ways to buy into this market through shares and crowdfunding. Interested investors can also buy into index funds that track with the art market.

Wine

Yes, wine. The reason that wine is an investment is there are a limited number of bottles produced each year by any particular winery. As the years go by, the number of bottles of each particular type of wine decreases, making each bottle more valuable.

Private Equity / Angel Investing

Individuals can invest in private companies through angel investing or private equity. This may be done individually or through a private equity firm. This is considered a high-risk investment, but if a private company goes public or gets acquired, these investments can do quite well.

Cryptocurrencies

A newer addition to the list of alternative investments, buying cryptocurrency is becoming widely accepted as a potential growth asset. As the cryptocurrency market matures, the regulatory environment is improving and more mainstream institutions are getting on board. For investors who don’t want to only invest in Bitcoin, there are now cryptocurrency ETFs available.

Collectibles

Collectible investments include coins, Beanie Babies, baseball cards, comic books, and other items that are only available in limited quantities. The thing about collectibles is that they are only worth what someone else is willing to pay for them.

So although a particular baseball card or vintage toy in its original box technically might be worth a certain amount, an investor will only make money if they can find someone willing to pay. Most collectibles are too common to actually have much value, but they can be fun to have.

Burial Plots

People interested in an alternative to traditional real estate can buy and sell burial plots in cemeteries for a profit.

Hedge Funds

A hedge fund is a pooled investment fund that invests in different public equities. They tend to invest in riskier assets, and sometimes they sell short— actually betting against a company’s success—which can be risky.

Some hedge funds require investors to be accredited, while others are available to all investors. The funds available to non-accredited investors are called funds of funds, because they are funds of hedge funds. This is an indirect way to invest in hedge funds.

Mineral Rights

People who own properties that have minerals on them can sell the rights to mine those minerals to mining companies. Minerals can include things like rock, diamonds, coal, or oil. Investors can also buy mineral rights and turn them into an income source.

Farmland

Like any real estate, farmland tends to increase in value over time. Owners of farmland can also sharecrop or lease out the land to earn income. This tends to be a long-term investment.

Equipment Leasing

This long-term investment option allows investors to buy into funds that own equipment that gets leased out to companies. This could include medical supplies, construction equipment, or other types of equipment.

Oil and Gas LPs

Oil and gas companies need ongoing investment to continue operating. Investors can buy into oil and gas LPs for exploration, land development, income, services, and support.

Timberland

The value of trees rises every year, so investors can buy into timberland and typically expect to earn a profit when those trees get harvested.

Trade Finance

When materials and products are shipped across borders, there are import and export fees that must be paid, and these can add up to significant amounts. In order to finance these costs, companies take out loans or get private investment. Investors can help finance these trades and get paid back with interest.

Marine and Aviation Finance

It’s extremely expensive to build and purchase ships and planes, so companies take out loans or get private investment to finance these operations. This type of investment can be risky, since changes in tariffs or the global economy can affect the market, but there is also significant potential for gains.

Film

A risky but fun investment, films have the potential to make a lot of money if they do well, but countless factors go into making them a success. Without an in-depth knowledge of the industry, film investing is very challenging to get into, though there are hedge funds and private equity funds that invest in films.

Franchise

One way for investors to bring in steady income and make a profit from growth is by buying a franchise. A few well-known franchises are McDonald’s, Taco Bell, and Dunkin’ Donuts. Investors can buy one or more locations, giving them an instant business with brand recognition. These franchises can bring in income and also make money when they’re sold. However, investing in franchises is a lot of work and not a passive investment.

Distressed Debt

Investing in distressed debt means buying up a company’s debt and hoping that they will be able to pay it back. This is extremely risky because companies with distressed debt are failing or near bankruptcy, so the likelihood is fairly low that they will be able to pay it back. However, if they do, the returns are typically high.

Intellectual Property

Intellectual property (IP) includes things like images, inventions, and names. IP has the potential to continue increasing in value forever, but it’s challenging to figure out exactly what intellectual property to invest in. One way of going about it is seeking out the next big brand, which is known as brand investing.

How Much Should go Towards Alternative Investments?

It is really up to each individual to decide how much they want to allocate to alternative investments. Financial experts generally recommend a range of 7-12 percent of one’s portfolio. That said, there are many different types of alternative investments, so investors will need to decide which ones to invest in and how much of each.

Alternative Investment Strategies

There are several ways that investments can make money. Each alternative investment is different, so investors should consider what their goals are when choosing assets to buy. Alternative investments can fall into one of three categories:

•  Income: Some alternative investments can provide a steady source of income, such as a rental property or a franchise.
•  Growth: This type of investment can appreciate in value significantly over time. Growth investments include assets like art and wine.
•  Balance: Some investments can provide a balance of growth and income, such as real estate that acts as a rental property but also increases in value over time.

Pros of Alternative Investments

There are many reasons investors should consider adding alternative investments to their portfolio. They offer protection from the volatility of the stock market and potential for high returns. Below are some of the benefits of alternative investments.

•  Increased portfolio diversification
•  Reduced risk exposure
•  Potential for higher-than-average returns (for example, hedge funds aim for returns between 25-30 percent)
•  They’re a good hedge against inflation and rising interest rates
•  May have lower transaction costs
•  Accessible to non-accredited investors through alternative mutual funds and exchange-traded funds
•  Appeal to an individual’s personal areas of interest, such as art or wine

Cons of Alternative Investments

Like any investment, alternative investments come with their share of downsides. It’s important for investors to do their due diligence when researching and considering alternative investments. They can come with a high degree of risk, so investors should be aware of those risks and how to handle them.
These are a few cons to consider:

•  Often limited to accredited investors (net worth of at least $1 million or an individual income of at least $200,000) and qualified purchasers who are allowed to invest in riskier securities that are not registered with financial regulators
•  Can be less liquid than traditional investments due to limited availability of buyers and lack of a convenient market. Sometimes investors are required to hold their money in the asset for five or more years.
•  May have high minimum investment requirements
•  May have high upfront investment fees
•  Less available data and transparency about performance
•  Potential for higher loss
•  May lack a clear legal structure since they aren’t required to register with the SEC
•  It can be difficult to determine value if the asset is rare and has few transactions
•  Vulnerable to fraud and investment scams since they are unregulated

The Takeaway

Alternative investments have the potential for high returns and are a good way to diversify your portfolio and reduce risk. And the sheer scope and variety of these investments means investors can look for one (or more) that suits their investing style and financial goals.

The first step for any investor who plans to add alternative investments to their portfolio is deciding which ones are of personal interest, and which work with their risk tolerance and investing goals. It’s important to research and do due diligence on any alternative investment option in order to make the best purchasing decisions and reduce risk. While some alternative investments are less accessible, others can be purchased through funds and ETFs.

One way to start investing in alternative investments is by using an online platform like SoFi Invest®. The trading platform lets members research and track their favorite stocks and assets, and build their portfolio right from their phone—buying and selling stocks, ETFs, cryptocurrencies, and more with a few clicks.

Ready to learn more about investing with SoFi Invest?


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