What Is an Alternative Investment?
There are three core types of investment vehicles: stocks, bonds and cash. In principle, these amount to investments in equity securities, debt securities and currency. But these aren’t the only investment options out there.
What is an alternative investment? As the name implies, it’s a type of investment that ranges outside the typical stock, bond or currency play. These can range from common to exotic, and your investment in them largely depends on how you want to diversify your core portfolio. Alternative investments are becoming more and more popular with investors as they become increasingly lucrative – and they’re more attainable than you might realize.
A Look at Traditional Investments
Traditional investments are widely accessible to anyone. They’re considered the foundational elements of investing and are all regulated by the Securities and Exchange Commission (SEC).
- Stocks: Equity securities, representing an ownership claim to a fraction of the company’s assets or earnings. Stocks trade through exchanges or in OTC markets.
- Bonds: Debt securities, representing the promise of returned principal plus interest. They’re obtained from companies or governments, or they can be acquired secondhand through bond markets.
- Cash: Currency investments, typically traded as pairs on forex markets. Cash products also encompass cash accounts such as money markets.
These investments are considered traditional because there’s a very low barrier to entry in buying and selling them. They’re also the foundational elements of most major portfolios and funds.
Examples of Alternative Investments
Let’s turn our attention to alternative investments. These are investments with a higher barrier to entry. They’re generally unregulated by the SEC, but they may face regulation from other entities. Some of the most common types of alternative investments include…
- Real estate. Real property investments are attainable by many retail investors but come at a much higher cost. Moreover, there are upkeep costs and taxes that differentiate them from traditional investments.
- Crypto assets. Cryptocurrency is hugely popular as an alternative investment. Bitcoin and other altcoins aren’t tied to fiat currency, which makes them a pure-play investment. Joining cryptocurrencies are nonfungible tokens (NFTs), which are akin to digital originals – anything from artwork to video clips.
- Derivatives. Because they represent a contract that pertains to underlying securities, derivatives are an alternative investment. They’re intangible, which makes them difficult for many new investors to grasp. Derivatives can encompass stocks, bonds, currencies and a wide assortment of commodities.
- Commodities. Livestock, crops, oil, metals, energy and more are all commodities. They’re considered alternatives for several reasons. First, most investors will find exposure to them only from a derivative standpoint. Second, it’s nearly impossible for retail investors to tangibly own them. Finally, they’re subject to broad external factors beyond market sentiment.
- Private equity. The high barrier to entry makes private equity unattainable for the average investor. While back-of-the-napkin deals may come across the table, they don’t usually amount to significant sums.
- Collectibles. Collectibles exist in a niche market. Coins, memorabilia, sports collectibles, stamps, trading cards and even cars exist in this space. It’s often difficult to nail down a value on collectibles, and that value isn’t always agreed upon.
Any investment that’s not a stock, bond or currency falls under the “alternative” umbrella. If it holds value and will gain value over time, it’s an investment.
The Role of Alternative Investments
Alternative investments play several important roles, depending on the situation and the investment itself.
For high net worth individuals with heavy market exposure, these investments are a hedge. For example, you might invest in negative futures to hedge against your bullish position in the market. Or you might take profits from a bullish market and invest in real estate to assume a more defensive stance. Each alternative investment increases exposure to new areas of value. Your energy-sector-focused portfolio may take a beating this year, but you can sell a few rare coins to offset the losses!
The other role of alternative investments is to explore untapped value. A PSA 10 gem mint Michael Jordan rookie basketball card sold for $738,000 in 2021, at a time when uncertainty clouded the stock market. Likewise, you never know when your investment in a local small business will turn into a regional franchise that rakes in millions. There’s value outside of traditional investments if you know where to look and how to assess it.
There’s one more benefit of alternative investments: insurability. Investors can be protected against loss by everything from collectors’ insurance to riders for high-value items. There is no protection like this for traditional investments – if the stock goes down, you lose your money. For some alternative investments, the value of an insurance policy is enough to justify owning the assets, especially on top of significant value.
Should You Invest in Alternative Investments?
Alternative investments are becoming less and less “alternative” in today’s broad investment landscape. Whether you use them to diversify a traditional portfolio or as lucrative investment vehicles in and of themselves, assets beyond stocks, bonds and cash are worth exploring. Just be sure to understand the market for them and the risks that come from less liquid investments.
Should you invest in alternative investments? The answer depends. If you’re nearing retirement or extremely risk-averse, perhaps not. But they’re not a bad idea if you have the risk tolerance and want diversity.
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