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Why You Should Consider Alternative Investments
When it comes to investing, investors have a lot of options. From stocks, bonds, ETFs to mutual funds, there are a plethora of options available. However, apart from these traditional asset classes, investors can also choose to make alternative investments. You might be wondering what alternative investments are? Well, alternative investments are investments in assets that do not fall into the conventional asset classes like stocks, bonds or cash. Alternative investments can be of multiple types, which can be in real estate, commodities, art, precious metals, private equity, and more.
We at Financial Education believe that alternative investments are a great way for investors to diversify their portfolio and increase their overall returns. Nowadays, several investors are shifting from traditional investments to alternative investments, as these investments are dynamic in nature and can help one achieve their financial goals efficiently. In this article, we shall go over what alternative investments are, why you should consider alternative investments, and much more! So, let’s get started.
What are Alternative Investments?
Like many people, you may have found yourself trying to understand the term ‘alternative investment’. This might be because a lot of investment options exist in the world beyond the stock market. When we refer to alternative investments, we simply mean every other investment that does not belong to the traditional investment category like bonds, cash, equity, etc. As volatility and uncertainty make investments in the stock market a bit risky, investing in alternative assets is a great way to diversify your investments and create a well-balanced portfolio.
Alternative investments include private equity, real estate, commodities, art, precious metals, tangible assets, etc. They do not include conventional investment options or categories. Alternative investments are mostly identified as assets that do not refer to the conventional investment categories. Alternative investments can therefore be assumed to include any physical item like a building, work of art, or anything intangible like an ownership stake in a business company.
In general terms, there is always a low correlation between alternative investments and traditional investments. Alternative investments when compared to traditional investments also have highly complicated valuations. Therefore, it’s common for investors to discover that some alternative investments are more commonly used in financial organizations and among individuals with high net worth.
Most people who acquire alternative investments use them to balance their portfolios. Additionally, alternative investments offer the benefit of diversification. This is also because alternative investments like gold, precious metals, vintage cars, fine arts, and wine, can be a great addition to an investor portfolio. When compared to traditional investments, oftentimes alternative investments provide greater returns and help in creating and compounding wealth for an investor.
Difference Between Traditional Investments and Alternative Investments
You may be asking yourself some obvious questions having understood what alternative investments are. It could be questions like; should I choose alternative investments over traditional investments? Are there any benefits or advantages of investing in alternative assets? What are the differences between alternative investments and traditional investments? Well, we at Financial Education are here to solve all your queries. So, let us go over some of the major differences between traditional and alternative investments –
Investment Criteria and Fees
One of the major differences between traditional investments and alternative investments is the capital requirement and fees. Traditional investments, such as stocks, bonds, or ETFs are assets in which an investor can start investing with a very small capital. There are no barriers to investing in traditional investments and you can start investing with any amount you wish.
However, alternative assets on the other hand are often expensive investments where high capital requirements are necessary. For example, alternative assets like hedge funds require investors to invest a minimum of $500,000 to $1 million, plus they charge a management fee, which can vary between 1% to 2%. This makes investing in traditional asset classes accessible and easy to all whereas several alternative investments are only available to high net-worth individuals.
Liquidity & Returns
Another difference between alternative investments and traditional investments is the level of liquidity. When it comes to traditional investments like stocks, entering and exiting your positions or investments is relatively easy as there is ample liquidity and you can easily liquidate your assets whenever required. However, certain alternative investments, for example; vintage cars, wine, or premium real estate are assets that cannot be liquidated in a short amount of time. Finding buyers and matching your demand price is a process that takes a lot of time.
So, when it comes to liquidity, traditional investments are highly liquid when compared to alternative investments. Traditional Investments are often more redeemable than alternative investments. It is not easy for investors to redeem their assets from alternative investments because they are not liquid investments. Because, unlike mutual funds which are a liquid traditional investment, you cannot trade real estate on the market to get cash whenever you need it.
However, when it comes to returns, alternative investments tend to deliver higher returns than traditional investments and are a great way to create a well-diversified portfolio that can help in generating wealth. According to Kate Stalter, a contributing editor of Forbes Investing, alternative investments such as managed futures and commodities delivered positive returns even during the bear market of 2008, whereas most traditional investments suffered.
Rules & Regulation
Another difference between alternative investments and traditional investments that one should consider is the regulations that govern your investments. When we talk about investing in the stock market, government bodies like the SEC monitor and ensure that the market functions in a fair and well-regulated manner. They prevent illegal activities and help save investors from financial frauds or scams. On the other hand, alternative investments usually do not have a governing body that regulates them.
There are, however, clear differences between the two forms of investment and each has its own positive and negative sides. Your decision to decide which one you would want to venture into depends on how much you are willing to invest and your ability to be comfortable with a regulatory oversight on your investment.
Why You Should Alternate & Diversify Your Investments
Founder of Financial Education, Jeremy Lefebvre believes that diversifying your portfolio has several benefits that can help you succeed as an investor while creating and compounding wealth. Adding alternative investments to your portfolio not only helps you diversify your portfolio, but also helps in reducing the impact of market volatility on your investments. A recent survey of over 500 institutional investors conducted by “Nataxis” found out that 71% of the investors believed that the returns offered by alternative investments made them worth the potential liquidity risk, and a majority of investors planned on increasing their allocation of alternatives.
When compared to traditional investments, alternative investments offer several advantages. Some of them are the following –
Diversification & Balanced Portfolio
Investing in alternative assets offers investors the ability to diversify their portfolio and ensure their investments are well balanced. When you diversify your capital over several different types of asset classes, you have a higher chance of preserving your capital when the overall markets are down or volatility is high. Adding alternative investments to your portfolio makes it more stable and less prone to volatile swings in the market.
Another benefit of adding alternative investments to your portfolio is that alternative investments are less volatile than traditional investments like stocks. This ensures that your invested capital remains well preserved and chances of volatility affecting and negatively impacting your overall portfolio are reduced. Generally, alternative assets have been less volatile when compared to other traditional asset classes.
Better Returns & Passive Income
Several alternative investments offer a better and higher rate of return than traditional investments. This improves your chance of generating wealth in the long run. Additionally, alternative investments are a great way of generating passive income. Several alternative investments offer the benefit of generating income even while you sleep and therefore, require no input from your side. This helps in creating multiple income streams, which therefore helps you in achieving your financial goals much more efficiently.
Types of Alternative Investments
Apart from the traditional forms of investment which include stocks, bonds, and cash, investors also have the option of investing in alternative assets, which are one of the most dynamic asset classes. Alternative investments include a wide range of assets and have become easily accessible to retail investors.
Nowadays, there are a plethora of alternative investments available to investors. These alternative investments differ in both their structure and accessibility and it is, therefore, necessary to identify a few characteristics amongst them. The characteristics of alternative investments include:
- Alternative investments do not necessarily relate with other assets in the market and therefore do not move in the same direction. This means that they are extremely efficient assets because low correlations and volatility give room for balance and diversification.
- Alternative investments cannot be sold or converted to cash easily thus they are often termed as illiquid or low liquidity assets.
- Alternative investments usually have high purchasing costs. This is because they usually require a minimum investment amount and a fee.
- Alternative investments are usually complicated when it comes to valuation. This is because their value is often determined by specific knowledge available.
Now, let’s go over some of the main alternative investments available to investors:
1. Real Estate
Real Estate is one of the most common types of alternative investment. It simply refers to land or properties that someone holds for financial and profitable purposes. Here, property owners receive their cash and profit from the rent their tenants pay or via the appreciation of their assets over time. Real estate includes assets like land, buildings, shopping malls, city buildings, factories, etc.
Profits can be generated from real estate through rental income, property value appreciation, and discoveries made on land. You can also profit from real estate by selling or liquidating your property. The location of a property, how developed its surroundings are, and the improvements you make on it are some of the factors that can improve the value and worth of the property.
2. Private Equity
Private equity generally refers to capital investments made in private companies. These companies are not found or listed on any public stock exchange. Investors contribute capital to a company and then receive returns on their initial investment once the company reaches a certain stage, often an initial public offering of stock or a merger. Private equity investments often fund new start-ups that have high potential.
Private equity investments aim to invest in the growth of new businesses and help them develop faster. The purpose is also to add value by restructuring new and existing businesses which have the potential of generating long-term profits.
Commodities are physical materials and natural resources that are sold and bought in the market in order to generate profits. They are also used to create other consumer products like livestock, crops, metals, etc. Because commodities are traded in the market, investors can either buy or sell them directly in the stock market or through derivatives.
Commodities like precious metals; gold or silver are popular alternative investments that investors can add to their portfolios. Commodities are not sensitive to the public equity market and are considered a hedge against inflation. The higher the demand for a particular commodity, the higher its value increases and vice versa.
Fine art or exquisite paintings are perfect examples of alternative investments. Fine art is generally considered a good investment as historically, the price fluctuations and volatility in the art market are comparatively less when compared to other assets like stocks and art also offers high level value appreciation. This in turn can help investors amass huge fortunes, provided the art they collect and invest in is highly valuable and collectible.
Now, with all this information, we hope that you have understood what alternative investments are and why you should add them to your portfolio. Alternative investments are most suitable for portfolio diversification and usually have a low correlation with traditional assets like stocks or bonds. While the minimum investment and structure fee in alternative investments are usually high, they also offer higher returns and help in generating huge wealth.
However, before making any investment decision, always check the current market conditions and other factors that might affect the value of an asset class, as investments in the financial market are subject to market risk. If you liked this article, make sure to visit Jeremy Lefebvre’s YouTube channel “Financial Education” for more such informative content! Happy investing!