Table of Contents
A growing number of investors are intrigued by alternative investments, due in part to factors like today’s lower-yield environment and volatility in the equity markets. Because alternative investments are not typically correlated with conventional stock and bond markets they can offer investors portfolio diversification and potential returns.
In addition, alternative assets — which fall outside conventional stock, bond, and cash options — used to be accessible only to high net-worth and accredited investors. Now “retail alts” have emerged as a category. These investments are available to a range of investors thanks to new vehicles that include different types of funds and alternative strategies.
That said, alternative assets and alternative strategies are generally less well regulated, and can be opaque and illiquid. In short, alts come with their own set of risk factors for investors to consider.
Key Points
• Alternative investments are generally not correlated with traditional stock and bond markets, so they can help diversify a portfolio and reduce risk.
• Alternative investments may deliver higher returns when compared with conventional assets, but are typically higher risk.
• Alternative investments are generally less liquid and less transparent than conventional securities, so there can be limits on redemption, a lack of data, and less regulatory oversight.
• Retail investors have more access to alternative strategies through certain types of funds and other vehicles.
• Alternative investments may be suitable for investors who have a higher risk tolerance, are looking for diversification, and understand the potential advantages and disadvantages of these investments.
Why Consider Alternative Investments?
Not only are alternative strategies more accessible to ordinary investors today, they offer several ways to add diversification to investors’ portfolios. Alternative investments come with risks of their own (see “Important Considerations” below), and investors need to weigh the potential upside of different alts with their disadvantages.
Unique Investment Options
For investors seeking diversification — or otherwise drawn to invest in a wider range of opportunities — the world of alts offers a number of options when investing online or through a traditional broker.
Alts can include tangible assets like commodities, farmland, renewable energy, and real estate. Alternatives also include art and antiques, as well as other collectibles (e.g. antiquarian books, vinyl LPs, toys, comics, and more).
In addition, alternative investments can refer to strategies like investing in private equity, private credit, hedge funds, derivatives, and venture capital. These vehicles may deliver higher returns when compared with conventional assets, but they are typically considered higher risk and generally more illiquid, owing to their use of leverage and short strategies and other factors. Some are available only to institutional investors or accredited investors.
Diversification
Investors wondering why to invest in alternatives often focus on diversification. Why does diversification matter? As many investors saw in recent years, volatility in the equity markets can take a bite out of your portfolio, as can inflation and interest rate risk.
In order to help mitigate those risks, adding alternatives to your asset allocation may provide a literal alternative to conventional markets, because for the most part these assets don’t move in tandem with the stock or bond markets.
In a general sense, diversification is like taking the age-old advice of not putting all your eggs in one basket. An investor can’t avoid risk entirely, even when self-directed investing, but diversifying their investments can help mitigate the risk that one asset class poses.
However, the challenge with alts is that there are no guarantees of how an alternative asset might perform. And because these assets are generally less liquid and not as highly regulated as most other securities, i.e. stocks, bonds, mutual funds, and exchange-traded funds (ETFs), there can be limits on redemption — and a limited understanding of real-time pricing.
Alternative investments,
now for the rest of us.
Explore trading funds that include commodities, private credit, real estate, venture capital, and more.
The Role of Alts in Your Portfolio
Taking all that into account, what could be the role of alts in your portfolio? In other words, why invest in alts? Of course, alternatives should only be part of your asset allocation. How much to put into alts would depend on your risk tolerance and overall financial goals. Here are some factors to consider.
Low Correlation With Stocks
As noted above, most alternative strategies are uncorrelated with conventional stock and bond markets. During periods of volatility or uncertainty in these markets, some investors may find alternative investments more appealing.
That doesn’t mean that alternatives will always outperform bonds or equities. Low correlation means that a particular asset class moves in a different direction than conventional markets. So, if the stock market drops, uncorrelated asset classes like commodities or real estate are less likely to experience a downturn — which may help mitigate losses overall.
The challenge with alts is that some of these assets (e.g. commodities, renewables, private equity, venture capital) come with their own intrinsic forms of volatility, and investors need to keep these risk factors in mind as well.
Tax Treatment of Alts
Generally speaking, investment gains are taxed according to capital gains tax rules. This isn’t always the case with alternative investments.
It may be a good idea to consult with a tax professional because alts don’t necessarily lower your investment taxes, but they are taxed in different ways. For example, collectibles (e.g., art and antiques) held for longer than a year can be taxed at a special long-term capital gains rate of 28%. Gains from a Real Estate Investment Trust, or REIT, can be subject to more complex taxes.
Important Considerations When Choosing Alternative Investments
Investing in alts requires careful thought because these assets aren’t traded or regulated the same way as more conventional securities.
Liquidity
Generally speaking, most alts are far less liquid than conventional assets. This can make them hard to evaluate in terms of price, and harder to trade. In addition to which, there can be limits on redemption, depending on the asset. Some alts only allow redemptions quarterly or twice a year.
Lack of Data
Owing to the lack of regulation in some sectors, it can be difficult to obtain accurate price history and trading data for some alts. This also adds to the challenge of trading some of these assets.
Who Should Invest in Alts?
Although some alternatives can be highly risky and expensive, some retail investors may want to consider alts because of the advantages these assets offer in terms of diversification and helping to reduce risk.
The investors who decide to invest in alts today may be drawn to the number of options available via mutual funds and ETFs, many of them offered by well-established asset managers. And in some cases, including alts in a portfolio may capture some of the desired advantages.
That said, investors need to do their due diligence to understand the potential pros and cons of these instruments.
The Takeaway
Alternative investments are on the radar of many investors today because these assets may offer some portfolio diversification, help tamp down certain risks, and potentially improve risk-adjusted returns. In addition, the sheer scope and variety of these investments means investors can look for one (or more) that suits their investing style and financial goals.
That said, unlike more conventional investments, alts tend to be higher risk, less transparent, and subject to complex tax treatment. Thus, it’s important to do your due diligence on any investment option in order to make the best purchasing decisions and reduce risk.
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.
Photo credit: iStock/Ridofranz
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
For disclosures on SoFi Invest platforms visit SoFi.com/legal. For a full listing of the fees associated with Sofi Invest please view our fee schedule.
An investor should consider the investment objectives, risks, charges, and expenses of the Fund carefully before investing. This and other important information are contained in the Fund’s prospectus. For a current prospectus, please click the Prospectus link on the Fund’s respective page. The prospectus should be read carefully prior to investing.
Alternative investments, including funds that invest in alternative investments, are risky and may not be suitable for all investors. Alternative investments often employ leveraging and other speculative practices that increase an investor's risk of loss to include complete loss of investment, often charge high fees, and can be highly illiquid and volatile. Alternative investments may lack diversification, involve complex tax structures and have delays in reporting important tax information. Registered and unregistered alternative investments are not subject to the same regulatory requirements as mutual funds.
Please note that Interval Funds are illiquid instruments, hence the ability to trade on your timeline may be restricted. Investors should review the fee schedule for Interval Funds via the prospectus.
Third Party Trademarks: Certified Financial Planner Board of Standards Center for Financial Planning, Inc. owns and licenses the certification marks CFP®, CERTIFIED FINANCIAL PLANNER®
Tax Information: This article provides general background information only and is not intended to serve as legal or tax advice or as a substitute for legal counsel. You should consult your own attorney and/or tax advisor if you have a question requiring legal or tax advice.
Exchange Traded Funds (ETFs): Investors should carefully consider the information contained in the prospectus, which contains the Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or by emailing customer service at [email protected]. Please read the prospectus carefully prior to investing.
Mutual Funds (MFs): Investors should carefully consider the information contained in the prospectus, which contains the Fund’s investment objectives, risks, charges, expenses, and other relevant information. You may obtain a prospectus from the Fund company’s website or clicking the prospectus link on the fund's respective page at sofi.com. You may also contact customer service at: 1.855.456.7634. Please read the prospectus carefully prior to investing.Mutual Funds must be bought and sold at NAV (Net Asset Value); unless otherwise noted in the prospectus, trades are only done once per day after the markets close. Investment returns are subject to risk, include the risk of loss. Shares may be worth more or less their original value when redeemed. The diversification of a mutual fund will not protect against loss. A mutual fund may not achieve its stated investment objective. Rebalancing and other activities within the fund may be subject to tax consequences.
Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.
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.
SOIN-Q425-002