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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 potential 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 such as mutual funds and exchange-traded funds (ETFs), as well as some retirement accounts, such as certain types of individual retirement accounts (IRAs).
Key Points
• Alternative investments are assets outside the usual mix of stocks, bonds, and cash, and they can include asset classes such as real estate, commodities, private equity, and collectibles.
• One reason people consider alternative investments is that they may help diversify a portfolio because they do not always move in the same direction as the stock or bond market.
• Some alternative investments may offer benefits such as passive income, inflation protection, or the chance for higher returns, depending on the asset.
• At the same time, alternative investments often come with trade-offs such as potentially higher risk and fees, less liquidity, limited transparency, and more complex tax rules.
• Before investing in alternatives, it’s important to understand how they work, what risks they carry, and whether they fit your goals, timeline, and tolerance for risk.
Pros and Cons of Alternatives
Alternative investments may offer unique opportunities and trade-offs compared to traditional asset classes like stocks and bonds. While they may offer the potential for higher returns, enhanced portfolio diversification, and passive income generation, they can also present distinct risks or complexities. Depending on the asset, this may include illiquidity, higher risk of loss, higher fees, limited transparency, and complex tax rules.
Investors should consider the potential benefits and challenges of any alternative asset, from private equity, private credit, and foreign currencies to real estate or wine. Understanding these dynamics can help investors determine if alternatives align with their financial goals and risk tolerance.
| Pros and Cons of Alternative Investments | |
|---|---|
| Advantages | Disadvantages |
| May provide portfolio diversification. | Many alts have low liquidity and/or come with redemption restrictions. |
| May offer higher returns compared with traditional assets. | Alts may employ high-risk strategies like short selling and leverage. |
| May offer passive income opportunities. | Some alts could be subject to higher volatility in some circumstances. |
| May be a hedge against inflation or interest rate fluctuations. | Owing to lack of transparency, obtaining historic data on certain alternatives can be difficult. |
| Accessible through ETFs and mutual funds, and in some cases via traditional retirement accounts (e.g. IRAs). | Investing directly in alternatives, or via a fund, may require complex tax treatment that varies from one asset class to the next. |
| Alts may appeal to investors’ personal hobbies and interests (e.g., wine, art, collectibles). | May require high minimum investment and often charge higher fees. |
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 some 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, such as hedge funds, private equity, venture capital, and derivatives trading, employ high-risk strategies, including 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, such as 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 such as 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: 2025-2026 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, such as 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 market sectors — e.g., private equity, private credit, real estate, or 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.
Alternative investments,
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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 that 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, a case of wine, or a 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, or deterioration) that can instantly erode the asset’s value.
Recommended: What Are Liquid Assets?
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, such as 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.
Potentially Higher Volatility
Alternative investments may have significantly higher volatility than traditional stocks and bonds, depending on the specific asset class and strategy. However, while some publicly traded alternatives might exhibit more extreme price swings, other assets’ volatility may not be as apparent as a result of their illiquidity and delayed pricing. For example, assets such as private equity and real estate may be valued less frequently, such as quarterly or annually.
At the same time, some alternatives may be used with the goal of reducing overall volatility in investors’ portfolios. This is because many alternatives may have a low correlation with the stock market, and may provide a hedge in volatile markets. Some may also use complex derivatives strategies to manage risk.
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.
Complex Tax Treatment
Some alts may offer certain tax advantages. However, alts can be taxed in different ways, and they don’t necessarily lower your investment taxes.
While many investment gains are taxed according to capital gains tax rules, that isn’t always true of alternative investments purchased directly or through 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 fees of 1%-2% and performance fees that can hit 20% of the profit made.
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, such as conventional mutual funds, ETFs, and even retirement accounts.
Alternatives may offer distinct potential benefits, such as the possibility of seeing high returns in exchange for higher risk and their potential to provide a hedge against market volatility. But alts do come with some notable risk factors that investors must take into account before embarking on any new strategies.
Ready to expand your portfolio's growth potential? Alternative investments, traditionally available to high-net-worth individuals, are accessible to everyday investors on SoFi's easy-to-use platform. Investments in commodities, real estate, venture capital, and more are now within reach. Alternative investments can be high risk, so it's important to consider your portfolio goals and risk tolerance to determine if they're right for you.
FAQ
What are alternative investments?
Alternative investments are assets that fall outside the usual categories of stocks, bonds, and cash. They can include assets such as real estate, commodities, private equity, hedge funds, and collectibles.
Why do people invest in alternative investments?
Some investors use alternative investments to add diversification to a portfolio because these assets may not move in step with the stock or bond market. Depending on the type of investment, they may also offer income potential, inflation protection, or the chance for higher returns. Investors should also consider the risks of each asset type, such as the potential for higher loss, alongside their goals.
What are the risks of alternative investments?
Alternative investments may come with drawbacks, such as the potential for higher losses, higher fees, limited liquidity, and less transparency than traditional investments. Some may also have complex tax treatment or be harder to value, which can make them riskier for some investors.
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