A Beginner's Guide to Alternative Investments
What is an Alternative Investment?
An alternative investment is an investment asset that does not fit into one of the conventional investment types, such as stocks, bonds, or cash. The term is used to describe investments in physical assets such as commodities, real estate, and collectibles, as well as financial assets such as hedge funds and private equity. Alternative investments are often seen as a way to diversify a portfolio and reduce risk.
Many alternative investments are illiquid, meaning they cannot be easily bought or sold and are often not heavily regulated by government agencies. While alternative investments may offer the potential for higher returns, they also come with higher risks. Before investing in any alternative asset, it is vital to do your research and understand the risks involved.
Who Can Buy Alternative Investments?
So, who can buy alternative investments? Generally speaking, if you have the money and the willingness to take on more risk, you can probably invest in some type of alternative investment. Of course, there are always exceptions, and some alternative assets may have additional requirements, such as being an accredited investor.
Each has different eligibility requirements. For example, hedge funds are only available to accredited investors, generally individuals with a net worth of $1 million or more or an annual income of $200,000 or more. Many real estate crowdfunding projects are only open to accredited investors as well, although there are several options in the non-accredited space, like Doorvest or other real estate investing platforms.
Types of Alternative Investments
When it comes to alternative investments, there are many options out there. And while some may fit with your investment goals more than others, they all offer unique benefits that can help you reach your financial goals, whether you’re looking for capital preservation, regular cash flow, or above-average growth.
Real Estate
Investing in real estate is a great way to diversify your portfolio and generate income through rental income and appreciation. There are a number of different ways to invest in real estate, including purchasing a property outright, investing in a REIT, or partnering with a real estate crowdfunding platform.
Hedge Funds
Hedge funds are private, unregulated investment vehicles that are often used to speculate on financial markets. They typically charge high fees and almost always have high minimum investment requirements, making them inaccessible to many investors.
Private Equity Funds
Private equity is an alternative investment that involves investing in non-publicly traded companies. Private equity firms typically invest in companies that are looking to grow or restructure. Investments in private equity are generally illiquid and have a higher risk than public equity investments.
Venture Capital Funds
The term venture capital fund describes an alternative investment fund that invests in early-stage and startup companies. Venture capital funds are typically managed by venture capitalists experienced in startup investments. Venture capital funds usually invest in companies in their early stages of development with high growth potential.
These companies are often too risky for traditional lenders such as banks to finance. Venture capitalists typically invest in companies in sectors with high growth potential, such as technology, healthcare, and biotechnology.
Fund of Funds
A fund of funds is a type of investment vehicle that allows investors to pool money together to invest in various underlying funds. This can provide investors with diversification and professional management while still giving them the flexibility to choose which underlying funds to invest in.
There are many different types of fund of funds, but most operate similarly. The fund of fund will collect money from investors and then use that money to invest in a variety of different underlying funds. The underlying funds can be of any type, but most fund of funds focus on investing in hedge funds, mutual funds, or private equity funds.
Commodities
Commodities are natural resources that can be used for commercial or industrial purposes. They include metals (such as gold, silver, and copper), energy (such as oil and natural gas), livestock (such as cattle and pork), and agricultural products (such as wheat, corn, and soybeans).
Prices for commodities are determined by supply and demand and other factors such as weather and political conditions. Because of this, commodity prices can be volatile, which can be both a risk and an opportunity for investors.
Pros and Cons of Alternative Investments
Like any investment asset, those classified as "alternative assets" have their own pros and cons.
The Pros
Diversification
By including alternative investments in your portfolio, you can help to diversify your overall investment mix. This can potentially reduce your risk and increase your chances of achieving your financial goals.
Higher Returns
Alternative investments can generate higher returns than traditional investments.
Risk Management
With alternative investments, you can often times hedge against specific risks. For example, you can invest in a hedge fund that is designed to protect against market declines.
Tax Advantages:
Some alternative investments offer tax advantages that can help you save money.
Access to Exclusive Investments
Many alternative investments are not available to the general public. This can give you access to unique opportunities that you would not otherwise have.
The Cons
High Fees
Alternative investments often come with high fees. This can eat into your returns and leave you with less money than you started with.
Complexity
Alternative investments can be complex and difficult to understand. This can make it hard to know what you are really investing in and how it will perform.
Illiquidity
Many alternative investments are illiquid, meaning you may not be able to sell them when you want. This can leave you stuck in an investment that is losing money.
Lack of Regulation
Alternative investments are often not as regulated as traditional investments. This can make them more risky and prone to fraud.
High Risk
Alternative investments are often very risky. This can lead to losses, even if the overall market is doing well.
Regulation of Alternative Investments
The Securities and Exchange Commission has long had regulatory authority over traditional investments, such as stocks, bonds, and mutual funds. More recently, the SEC has been extending its regulatory reach to alternative investments, such as hedge funds, venture capital, and private equity.
The SEC’s regulatory authority over alternative investments is derived from the Investment Advisers Act of 1940. The SEC has interpreted this law as giving it jurisdiction over any investment adviser who is “engaged in the business” of giving investment advice to clients. The SEC has also promulgated rules targeting hedge funds and other alternative investments.
This level of regulatory authority over alternative investments has been controversial. Some argue that the SEC is overreaching its authority by regulating these investments. Others argue that the SEC is necessary to protect investors from the risks associated with these investments.
The SEC’s regulation of alternative investments is still evolving. In recent years, the SEC has been actively engaged in enforcement actions against hedge funds and other alternative investments. And it is likely the SEC will continue to expand its regulatory reach to these investments in the future.
How to Buy Alternative Investments
As the term “alternative investments” encompasses a wide variety of different investment assets, there is no one way to purchase them. You might go through a broker, an online portal, or even a physical seller for an alternative investment like gold bullion. However, for the purposes of this article, we’re going to focus on one of the most popular, durable alternative assets- real estate!
How to Buy Real Estate
Crowdfunding/Fractional Ownership
One of the latest and greatest methods to invest in real estate is via fractional ownership of properties, either through a REIT or crowdfunded real estate. You can purchase fractional shares of almost any property type, from partial ownership of vacation rentals to a fractional share of a large-scale multifamily apartment portfolio.
Realtors
Realtors are licensed professionals who help people buy and sell the property. They can help you find the right property and negotiate the best price. You can find a realtor via word of mouth, the internet, or by meeting one at the many open houses in your area.
Online
Many websites, like Redfin and Zillow, allow you to search for properties and compare prices. You can also find information about properties and real estate agents online. You can also use online crowdfunding platforms to invest in real estate, like RealCrowd, RealtyMogul, AcreTrader, and Doorvest.com.
For sale by owner/FSBO
You can find properties for sale by owner by searching online or in your local newspaper. This is a great way to find a bargain, but you should be aware that you will not have the same protections as you would if you were working with a real estate agent. Pocket listings and off-market deals are increasingly popular in the US- with a recent Redfin study finding almost 20% of deals nationwide in 2021 were pocket listings.
Auction/Foreclosure
Auctions can be a great way to get a good deal on a property, but they can also be risky. You should do your research before bidding on any property. Foreclosure properties can be a great deal, but you should be aware of the risks involved. You should always have a professional inspect the property before you buy it.