In today's volatile market, most investors are seeking worthwhile alternatives to bonds and stocks to invest their money. This quest for alternatives results in alternative investments. Are they, however, useful additions to your portfolio? Let us examine the pros and cons of alternative investments.
Alternative Investments Meaning
Alternative investments come in a variety of sizes and forms. For some, an alternative is anything other than the stock market. Real estate is an alternative investment asset. Farmland is a valuable alternative investment asset.
Others require something "out of the ordinary" such as a collectible - think wine, art, and NFTs. Indeed, NFTs are elevating alternative investments to a whole new level.
These assets have generally been reserved for institutional or HNIs. But, these are gradually making their way into individual investors' portfolios. Alternative investments are often thought to be more complicated than most standard investing techniques. As a result, many of these asset classes were thought to be solely available to institutional and accredited investors.
Table of Pros Vs Cons Alternative Investments
Read below for more details.
Pros of Alternative Investments
Almost every financial adviser will tell you the same thing: investing in alternative investment assets is a good idea.
This is due to a number of important factors.
Pro #1: Less Correlation with the stock market
It's easy to see how a piece of real estate or a bottle of wine would not have a clear correlation with the stock market, and that's part of the allure.
If you own an index fund, such as the S&P 500, you have made a significant investment in technology. When looking at the S&P 500 Companies by Weight, the top six are tech (Apple, Microsoft, Amazon, Facebook, Alphabet/Google). They account for 20.7% of the index as of this writing. Stock market performance can influence other investments or rather the things that influence the market can influence other investments. So, it is best to have something that is not influenced by the market.
Pro#2: Improved performance
Increased performance is one of the possible benefits of alternative investments. Alternative investments, in fact, do not guarantee significant returns. Some, however, outperform established asset groups. For example, during the commodities boom that followed Covid-19, energy prices skyrocketed, resulting in massive profits. In 2021, coal delivered 160.61% returns. Meanwhile, oil and gas returned 55.01% and 46.91%, respectively.
Private equity funds have the potential to create substantial returns. In 2011, for example, a private equity firm earned up to 54%. These returns outperform the public stock market by 12%.
Alternative investments are often appealing to investors because they allow them to diversify their portfolios. Over the long run, returns for alternative investments have historically been modest in comparison to standard assets.
For example, the Bloomberg Commodity Index, which measures global commodity prices, has a 0.3 correlation with US stocks as measured by the S&P 500 Index. Furthermore, the commodity index has a 0.3 correlation with global bonds, as measured by the Barclays Global Aggregate Index.
Also, read Preparing for debt default: Investor Protection and portfolio diversification.
Pro# 4: Hedging volatility
Because of the minimal correlation, we may mix a less volatile portfolio. Furthermore, by incorporating alternative assets into our standard investing portfolio, we may optimize our risk and return profile.
As a result, when our traditional assets are down, we can possibly produce returns at a manageable risk level. As a result, when traditional assets decline in value, our portfolio does not suffer considerably.
Pro# 5: Tax Benefits
Some alternative investments provide tax advantages that other assets do not. Certain sorts of real estate investments, for example, may allow you to deduct certain expenditures when filing your taxes. This implies that investing in some real estate investments in alternative asset classes might possibly save you money on taxes.
Pro# 6: Improved accessibility
Alternative investments have always catered to uber-wealthy investors. However, it is getting simpler for ordinary individual investors to profit. Alternative investments, such as alternative mutual funds and exchange-traded funds, are also available to retail investors. These alternative funds are open to the public and SEC-registered, although they may contain non-traditional equities or apply complicated investment methods.
Cons of Alternative Investments
While there are several appealing pros, it is also critical to grasp the cons of alternative investments.
If you purchase a fractional share of art, you will be unable to sell it unless the platform supports a secondary market. Many do not have a secondary market since it would necessitate further regulation, thus you are stuck with your investment until it is sold. If you buy a publicly listed REIT, such as Crown Castle or American Tower, you can sell it whenever the market is open. You can only receive your money back from a private REIT if you redeem it with the corporation. If you redeem your shares early, there may be mandated holding periods and fines. There is little you can do if the fund decides to halt redemptions during a period of instability.
Con#2: Alternative Investment Platforms Can Fail
The platform promotes interaction in many of these alternative investments. You are still a limited partner in a company that exists independently of the platform. RealtyShares is one of the investment platforms that collapsed. It's never good to learn that a firm has failed after you've invested thousands of dollars in its platform.
Con#3: Scams, Fakes, and Frauds
You don't have to worry about shares of stock not being genuine. Fakes are an issue whether it comes to wine, collectible trading cards, or anything else that may be falsified. You can utilize a platform to vet the things, but this relies on the platform (or rating agencies) being 100% accurate - which may not be the case.
This is comparable to the dangers associated with real estate investment and secret (or undiscovered) issues with a piece of property. In such a situation, the property still has value (although decreased), whereas a phony collectible is useless.
Con#4: Price Transparency is Reduced
There are no public marketplaces for alternative investments. So, there is virtually little pricing information. It is easier to search the price of a stock than a piece of commercial real estate. You're left to look into previous sales and similar houses, which, if you've ever bought a property, may be difficult.
Con#5: A large initial investment is required
Most alternative investments need a considerable initial commitment. A private equity fund may need a minimum commitment of $25 million, even though some are smaller. They also require that we retain the investment for a minimum of ten years.
Hedge funds often need a $100,000 - $2 million minimum commitment. Similarly, the smallest investment in real estate is large.
Con#6: High fees
Hedge funds may charge a 2 percent fee of the total fund invested. It can also keep a portion of the excess returns (earnings beyond an agreed-upon benchmark). Meanwhile, while investing in equity funds, we must cover 2 percent of our pledged money in management costs. ETFs, while very affordable, contain a number of fees, and involve trading and operating charges.
Alternative investments, in general, are worthwhile additions to your portfolio. They widen your portfolio and may result in greater results. But before making any judgments, it is critical to recognize the risks involved. These investments may not be suited for everyone because they have higher costs and less liquidity. Before proceeding, it is critical to conduct research and develop a well-informed investing strategy.
Assetmonk is one of the most cutting-edge alternative investment platforms. On a budget, you may invest in alternative investment opportunities such as real estate. We increase the availability of alternative assets such as real estate. Get in touch with us by clicking on the link above.
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Q1. What are the risks of alternative investments?
A. The risks of alternative investments are:
Q2. What are 4 examples of alternative investments?
A. Real estate, collectibles, NFTs, and hedge funds are some examples of alternative investments.
Q3. Are alternative investments the future?
A. Alternatives are predicted to provide 50% of industry income during the next several years.
Q4. Is Gold an alternative investment?
A. Yes. Gold has always been seen as an alternative investment asset to typical assets such as equities and bonds.
Q5. What is the best-performing alternative investment?
A. Private equity is the best-performing alternative investment, and it's also where institutional investors aim to expand their asset allocation by 2025, with 79% stating they'll do so.