A diversified investment portfolio is a smart way to reduce your risk and smooth out market fluctuations. As your portfolio continues to grow, you may begin to look beyond traditional investments like stocks, bonds, and banking products to take advantage of more sophisticated and less-common investment vehicles.
These investments are collectively known as alternative assets. In this article, we'll define what they are, why you should (or should not) consider them, who they are best for, and how to invest in them.
What are alternative assets?
Alternative assets are investments that are not part of the standard asset classes of stocks, bonds, or certificates of deposit. These alternative investments range from common assets like real estate, gold, or collectibles to more exotic assets like soybean futures, paintings, cryptocurrency, or private equity.
These assets can be tangible or intangible. A tangible asset is one you can touch and feel. Tangible alternative assets could include things like rare stamps, a bottle of fine wine, or jewelry. Intangible assets are items that cannot be touched, such as commodity futures, private equity funds, and intellectual property.
Because these assets are not as common or often carry higher transaction costs, they tend to be more illiquid. In other words, it is more difficult or more expensive to buy and sell these alternative assets than a publicly-traded stock.
Examples of alternative assets include:
- Commodities (e.g., oil, corn, soybeans)
- Collectibles (e.g., fine wine, coins, art)
- Real estate (e.g., rental properties, farmland, timberland, mineral rights)
- Precious metals
- Intellectual property (e.g., copyrights, song rights, patents)
- Tax lien certificates
- Hedge funds
- Private equity
- Angel investing
- Venture capital
- Structured settlements
- Master limited partnerships
Why invest in alternative assets
There are many reasons why investors choose to add alternative assets to their portfolios, such as further diversification of their holdings, benefitting from favorable tax treatment, or taking advantage of their own unique skills or knowledge (when it comes to art or wine, for example).
Alternative assets are often non-correlated to stocks and bonds, which means their performance does not depend on the ups and downs of the market. Diversifying by investing money in non-correlated assets means you can reduce the impact of market volatility on your portfolio. This means your total portfolio value will not rise or fall as much when the stock market has large swings like it did during the Great Recession or in 2020 when COVID-19 scared the market.
Some alternative assets provide tax benefits to their owners. Real estate funds and syndications, for example, use depreciation to reduce taxable income. Oil investments receive a depletion allowance that excludes 15% of all gross income from taxation. Tax-loss carryforwards and tax credits can reduce your tax burden significantly. Even if these assets may not provide a high return, the value of those tax benefits can make them a worthwhile investment.
Finally, alternative assets can sometimes provide a way to utilize your unique skills and knowledge. Real estate developers, musicians, and sommeliers have expertise in their fields that give them an upper hand over the average person in the areas of real estate investing, song rights, and rare wines, respectively. They can use their knowledge to locate undervalued assets or investments that have the potential for outsized future gains.
When considering an investment in alternative assets, think about what unique skills or knowledge you have. Do you love real estate? Does mining cryptocurrency sound like fun to you? There might be an investment opportunity where you can yield a competitive advantage over other investors.
Why you might not want to invest in alternative assets
Alternative assets often have less liquidity and higher trading costs than traditional assets. They may also require extensive knowledge in a particular market niche. Some investors are able to do very well with alternative assets, but they often have expertise beyond the typical investor.
Alternative assets can be harder to liquidate (aka sell) when you want to exit that investment. Markets for these investments are typically much smaller than the stock market, such as art collectors, so there are fewer buyers available, willing, or able to purchase your offering. Some investments, like private equity or a hedge fund, also require investors to keep their money in place for a certain period of time.
Real estate investing is becoming a popular alternative asset class. However, it carries heavy transaction costs, has ongoing maintenance costs while you hold it, and can take longer to liquidate depending on market conditions. Real estate crowdsourcing platforms have launched in recent years, such as Diversyfund and Fundrise, to make it a more passive investment option. However, investors in Diversyfund and Fundrise should expect a holding period of at least five years before they can liquidate their investment.
Who are alternative assets best for?
Alternative assets are best for investors who already have a solid financial strategy in place and are looking to expand their portfolio. It is typically best to max out your retirement accounts each year, have three to six months’ savings in an emergency fund, and have adequate life and disability insurance in place before venturing into more sophisticated investment strategies.
That being said, some investors choose to eschew those financial principles and dive into alternative assets to take advantage of their expertise. This experience and knowledge allow certain investors to identify hidden opportunities the average investor cannot.
Investors that have achieved accredited investor status may also choose to participate in alternative assets in the pursuit of portfolio diversification. Some alternative assets, like hedge funds or private equity investments, may even require you to be an accredited investor in order to participate. To become an accredited investor, you must meet either income or net worth qualifications. The income qualification requires an annual income of $200,000 for each of the past two years ($300,000 for joint income) and an expectation that this income will continue going forward. Your net worth must exceed $1 million individually or with your spouse, excluding the equity in your primary residence.
Who are alternative assets not a good fit for?
As alluring as some of these alternative assets are, they are not a good fit for everyone. If you are struggling to pay your bills, do not have an emergency fund, or are not maxing out your traditional retirement accounts, it may be best to stay away from alternative assets for now.
The value of alternative assets can be more volatile and harder to quantify than more mainstream investments like stocks and bonds. Even a relatively common alternative investment like real estate properties can have a broad range of valuations depending on which appraiser is assigning its value. If you need a more consistent valuation of your investments, alternative assets may not be for you.
Many investors are saving for specific goals with a defined time frame, such as saving for a house or a child's college education. Some alternative assets require investors to hold investments for a minimum number of years. If you are able to get your money out at all, and there are no guarantees that you can, it may be subject to a substantial penalty. Saving for goals when you need the money out at a certain date may not work with alternative assets.
Although you may see other investors successfully using alternative assets to grow their wealth, you may not be able to replicate their success. These investors may have spent years, or even decades, honing their knowledge and studying these markets to earn their success. If you're interested in specific alternative asset classes, take steps to increase your knowledge of those investments. Seek out local investors you can speak with, take classes online or at a local college, buy books on the subject, and join online communities for people who share the same interests. The more you know before you invest, the greater your chances of success.
How to invest in alternative assets
With such a variety of alternative assets, there is no single way to invest in these assets. Even if you've narrowed your selection to a specific investment type, there will still be multiple methods of investing.
If you are working with an investment advisor, they may be able to help you invest, introduce you to experts in the particular market, or steer you in the right direction. Many companies are also eliminating the middleman by making it easier than ever for investors to participate directly through their apps and online services.
Here are a few examples of ways you can easily invest in alternative assets:
- Real estate: You can get into crowdsourced real estate investing through Diversyfund or Fundrise or purchase individual properties through Roofstock.
- Precious metals: You can purchase gold, silver, platinum, and other metals through Stash.
- Artwork: You can buy shares of iconic artwork, like paintings and sculptures, through Masterworks.
- Farmland: Become a fractional owner of farmland and rent it to farmers with Acretrader.
- Collectibles: You can own a piece of your favorite books, baseball cards, and other historic collectibles with Rally.
- Commodities: You can invest in commodities like oil, soybeans, or corn with many online brokerages.
If you don't feel comfortable investing in these items individually, look for companies, mutual funds, or exchange-traded funds related to these industries. For example, there are numerous publicly-traded REITs, mutual funds, and ETFs focused on many of these niches, such as the XLRE (real estate) and OILK (crude oil) ETFs.
Why are alternative assets important?
Alternative assets are important because they reduce the volatility of your portfolio and provide unique benefits for the right investors. These investments are often non-correlated to the stock market. This means their performance is not tied to whether the value of stocks and bonds go up or down.
Investors use these investments to hedge against inflation and fluctuations in currency and the stock market. Some alternative assets provide tax benefits to reduce the tax burden on an investor's income.
Alternative assets also provide an opportunity for investors to use expertise to choose investments that have a strong potential to increase in value. This insight allows educated investors to find hidden gems other investors overlook.
What are the best alternative investments?
The best alternative investments for your situation is a personal decision. As with all your other investments, any alternative assets you select should be chosen to align with your financial goals, risk tolerance, and time frame.
For example, it doesn't make sense to invest in an illiquid investment if you need the money for a down payment on a home in six months. That money is probably better off in a high-yield savings account or a short-term CD.
Investors who are on target with their financial plan may not mind the high-risk nature of alternative assets and may choose to invest their "fun money" for the novelty and potential for higher returns. For example, a wine connoisseur may have a rare wine collection for the potential gains and as something to discuss with friends who share the same passion.
Is now a good time to invest in gold?
Gold is often seen as a safe haven during times of volatility. When investors fear that the stock market is ready for a significant downturn, some move their money into gold and U.S. Treasury notes to preserve their capital.
What novice investors may not realize is that precious metals like gold also have a history of volatility. Plus, precious metals do not produce income or generate profits as businesses do. This makes these investments more prone to price swings due to emotion. So the answer to whether it’s a good time for you to invest in gold would be better based on your personal goals, existing portfolio, and risk tolerance.
Alternative assets offer investors the opportunity to diversify the asset allocation in their portfolios, utilize tax benefits, and gain a potential advantage by using their expertise. These investments often require a longer holding period and it may be more difficult to determine the value of the asset in the short-term. Alternative assets can be a solid addition to your investing strategy, but typically shouldn't be pursued until you have your financial foundation in place.
If alternative assets are right for you, many fintech startups have made it easier than ever to start investing in this way. These mobile apps have decreased the minimum investment required and increased the number of available options to investors.
As always, remember that past performance of any asset is not a predictor of future results and just because someone you know did well with an alternative asset doesn’t mean their opinion is investment advice you should follow. If you want to get involved in alternative assets, you might consider scheduling a session to speak with a financial advisor who is versed in the particular market you are looking to enter.
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