Exploring What is an Alternative Investment – Benefits, Types and Risks

Introduction

Alternative investments are a type of asset class that typically offers higher returns than traditional investments such as stocks, bonds, and cash. They can be used to diversify a portfolio and provide exposure to markets with higher growth potential. While they may carry more risk than traditional investments, alternative investments can offer investors the opportunity to increase their wealth and achieve financial goals.

Definition of Alternative Investment

Alternative investments are defined by the Financial Industry Regulatory Authority (FINRA) as “investments that do not fall into one of the three traditional asset classes: stocks, bonds, and cash.” These are investments that are not publicly traded on a stock exchange, but are instead traded through private transactions or over-the-counter markets. Examples include real estate, collectibles, private equity, venture capital, hedge funds, commodities, and cryptocurrency.

Overview of Benefits of Alternative Investments

Alternative investments offer a number of potential benefits to investors. They can provide diversification from traditional investments, which may help reduce risk and volatility in a portfolio. They can also provide access to markets with higher growth potential, such as emerging markets. Additionally, depending on the asset class, alternative investments may offer tax advantages and income generation opportunities. As noted by The Motley Fool, “alternative investments can provide investors with access to unique opportunities and potentially higher returns than traditional investments.”

Popular Types of Alternative Investments

There are many different types of alternative investments, each with its own set of characteristics and risks. Here are some of the most popular alternative investments:

Real Estate

Real estate is one of the oldest and most popular alternative investments. Investors can purchase property directly or invest in real estate investment trusts (REITs), which are companies that own and manage properties for investors. Real estate investments can generate income through rental payments, as well as capital appreciation when the value of the property increases. According to a survey by Deloitte, real estate was the most popular alternative asset class among institutional investors in 2019.

Collectibles

Collectibles are items that are collected for their rarity, historical significance, or aesthetic appeal. Examples include coins, stamps, art, antiques, and vintage cars. Investing in collectibles can be risky, as the value of the items can fluctuate significantly. However, the right pieces can be highly valuable and potentially generate significant returns for investors.

Private Equity and Venture Capital

Private equity and venture capital involve investing in privately held companies in exchange for ownership stakes. Private equity firms typically purchase controlling stakes in companies, while venture capital firms typically invest in startups in exchange for equity. These investments can be highly rewarding, but they also come with high levels of risk.

Hedge Funds

Hedge funds are pooled investments managed by professional money managers. Hedge funds use a variety of strategies to generate returns, such as short selling, leverage, and derivatives trading. Hedge funds are typically only available to accredited investors, and they often come with high fees and minimum investment requirements.

Commodities

Commodities are physical goods that are used as raw materials or inputs for production. Examples include oil, gas, gold, silver, copper, wheat, and corn. Commodities can be traded on futures exchanges, which are markets where traders can buy and sell contracts for delivery at a later date. Commodity trading is risky, but it can generate significant returns for investors.

Cryptocurrency

Cryptocurrency is a digital form of currency that is secured using cryptography. Bitcoin is the most well-known cryptocurrency, but there are now thousands of different cryptocurrencies available for trade. Cryptocurrency investing is highly speculative and carries a high level of risk, but it has become increasingly popular in recent years.

Pros and Cons of Investing in Alternatives

Alternative investments offer investors the potential for higher returns, but they also come with increased risk. It’s important to understand the pros and cons before investing in alternatives.

Advantages of Alternative Investments

Alternative investments can provide access to markets with higher growth potential, such as emerging markets. They can also be used to diversify a portfolio and reduce risk. They can also offer tax advantages and income generation opportunities. According to a report by the World Economic Forum, “alternative investments can provide investors with exposure to new asset classes and markets, which can help to diversify portfolios and generate returns that may be uncorrelated or less correlated to traditional asset classes.”

Disadvantages of Alternative Investments

Alternative investments can be complex and difficult to understand. They also tend to have higher fees and minimum investment requirements than traditional investments. Additionally, alternative investments may be illiquid, meaning it can be difficult to sell them quickly. As noted by Investopedia, “alternative investments are generally considered to be more speculative and risky than traditional investments, and these investments may not be suitable for all investors.”

How to Evaluate an Alternative Investment

When evaluating an alternative investment, there are several factors to consider. Here are some tips for evaluating an alternative investment:

Research the Market

It’s important to research the market in which you plan to invest. This includes understanding the industry, competitive landscape, economic climate, and regulatory environment. It’s also important to understand the investment strategy and track record of the fund manager.

Understand the Risk Profile

Alternative investments can be risky, so it’s important to understand the risks involved. This includes understanding the potential rewards and potential losses associated with the investment. Additionally, it’s important to understand the liquidity of the investment, as some alternative investments may be difficult to sell quickly.

Consider Your Investment Objectives

It’s important to consider your investment objectives when evaluating an alternative investment. Ask yourself why you are investing and what you hope to achieve. Are you looking for short-term gains or long-term growth? Knowing your investment objectives can help you make better decisions about which investments to pursue.

Understanding the Risks of Alternative Investments

Alternative investments can be risky, so it’s important to understand the specific risks associated with each type of investment. Here are some of the risks associated with alternative investments:

Liquidity Risk

Alternative investments can be illiquid, meaning it can be difficult to sell them quickly. This can be a problem if you need to liquidate your investments quickly in order to access cash. It’s important to understand the liquidity of the investment before investing.

Investment Fraud Risk

Alternative investments can be vulnerable to fraud. It’s important to research the fund manager and verify their credentials before investing. Additionally, it’s important to understand the terms of the investment and make sure you are comfortable with the level of risk involved.

Inflation Risk

Inflation can erode the purchasing power of your investments over time. It’s important to understand the inflation risk of each investment and make sure you are comfortable with the potential return after inflation.

The Future of Alternative Investments

Alternative investments are becoming increasingly popular, and the industry is expected to continue to grow in the coming years. Here are some of the trends to watch out for in the future of alternative investments:

Increasing Popularity

Alternative investments are becoming increasingly popular among retail and institutional investors. According to a survey by Deloitte, 92% of institutional investors plan to increase their allocations to alternative investments over the next five years. This trend is likely to continue as investors look for new ways to diversify their portfolios and generate higher returns.

New Opportunities

The emergence of new technologies, such as blockchain, artificial intelligence, and machine learning, is creating new opportunities for alternative investments. These technologies are enabling investors to access a wider range of investments, including tokenized assets and security tokens.

Regulatory Changes

Regulatory changes are also having an impact on the alternative investments industry. For example, the SEC recently proposed a new rule that would allow companies to raise capital through crowdfunding platforms. These changes are making it easier for investors to access alternative investments and providing greater transparency and protection for investors.

Conclusion

Alternative investments can provide investors with access to markets with higher growth potential, diversification benefits, and the potential for higher returns. However, they come with increased risk and should be approached with caution. It’s important to understand the benefits and risks of each type of alternative investment, as well as how to evaluate and select investments. With the right approach, alternative investments can be a powerful tool for achieving financial goals.

Summary of Benefits of Alternative Investments

Alternative investments can provide access to markets with higher growth potential, diversification benefits, and the potential for higher returns. They can also offer tax advantages and income generation opportunities.

Final Thoughts

Alternative investments can be a powerful tool for achieving financial goals, but they come with increased risk. It’s important to understand the benefits and risks of each type of investment, as well as how to evaluate and select investments. With the right approach, alternative investments can be a valuable addition to any portfolio.