Looking to elevate your investment game? Exploring alternative investments can open up exciting new opportunities beyond traditional stocks, bonds, and cash, offering a dynamic way to diversify your portfolio.
While many Americans rely heavily on mutual funds and equities—52% invest in mutual funds, and 62% say they own stocks—adding alternative assets can help spread risk and potentially boost returns. These investments often offer a hedge against inflation, diversification, and, in some cases, higher returns.
However, they also come with unique challenges and risks that traditional assets may not.
What are Alternative Investments?
Alternative investments offer a different route to diversifying a portfolio that might already be heavy in traditional stocks, bonds, and mutual funds. These investments are generally not traded on public exchanges. They can range from real estate and hedge funds to commodities and private equity.
One key advantage is that alternative investments can reduce risk exposure because they often don't move in lockstep with traditional financial markets.
For example, while the stock market might be volatile, assets like real estate or gold may perform well, offering a buffer against stock market fluctuations.
However, these assets aren't as liquid as stocks or bonds, so they can be harder to sell when needed.
Investing in alternatives often requires more research and due diligence, and sometimes, there are higher financial barriers to entry. These investments are sometimes only available to accredited investors—individuals with significant income or net worth.
Therefore, it's essential to understand the specific risks and rewards associated with each asset before diving in.
5 Popular Alternative Investment Options
Gold
Gold is often seen as a safe bet in times of financial uncertainty, and for centuries, it has been a reliable store of value. When inflation rises or economies face instability, gold prices often increase, making it a popular hedge against inflation.
You can purchase physical gold, such as coins or bars, or invest through more accessible options like gold-backed exchange-traded funds (ETFs) and mutual funds. While owning physical gold can provide peace of mind as a tangible asset, it comes with storage and insurance costs. Gold ETFs offer an easier way to gain exposure to gold's price movements without dealing with physical storage.
Though historically stable, gold prices can fluctuate in response to market conditions, so assessing how it fits into your broader financial plan is essential.
Cryptocurrencies
Cryptocurrencies represent one of the most innovative—and volatile—alternative investments available today. Bitcoin, the leading cryptocurrency, is often viewed as “digital gold” because it's decentralized and not directly tied to any government or traditional financial system. Other common cryptocurrencies include Ethereum, Binance Coin, Solana, Dogecoin, and Tether.
While cryptocurrencies have the potential for high returns, they also come with equally high risks. Prices can experience dramatic swings in short periods, making them more volatile than other assets.
A real-life example of cryptocurrency volatility occurred in May 2021, when Bitcoin’s price dropped from an all-time high of around $64,000 in April to below $30,000 by mid-June. This dramatic decline was triggered by several factors, including Elon Musk’s announcement that Tesla would stop accepting Bitcoin due to environmental concerns and China’s crackdown on cryptocurrency mining and transactions.
These events caused a sharp sell-off in the cryptocurrency market, with other digital assets like Ethereum and Dogecoin also experiencing significant drops. The rapid price swings demonstrated the extreme volatility of cryptocurrencies due to news, regulations, or even social media activity.
Additionally, the regulatory landscape surrounding cryptocurrencies is still evolving, with some countries embracing them and others imposing bans.
If you're considering cryptocurrencies as an investment, it's crucial to be aware of their volatility and the regulatory risks involved.
SPACs (Special Purpose Acquisition Companies)
SPACs, also known as “blank check” companies, have become a popular way for private companies to go public without going through the lengthy traditional IPO process. A SPAC raises money by going public through an IPO and then seeks to merge with a private company, allowing that company to become publicly traded.
SPACs attract investors because they offer the potential to get in early on a growing company. However, SPAC investments come with risks.
When you buy into an SPAC, you don't know which company it will eventually merge with, creating uncertainty. There is also generally less regulatory disclosure than traditional IPOs, increasing the investment risk.
A real-life example of both the attraction and risks of SPACs can be seen in the case of Nikola Corporation. In 2020, Nikola, an electric truck company, went public through a SPAC merger with VectoIQ Acquisition Corp. Initially, investors were excited about getting in early on a company positioned to compete in the electric vehicle market, and Nikola's stock price surged, reaching a market capitalization of over $30 billion at one point—higher than some established automakers.
However, the risks soon became evident. Later that year, a report by Hindenburg Research accused Nikola of misleading investors, including falsely claiming to have proprietary technology. This led to a significant drop in the company's stock price, an investigation by the SEC, and the resignation of its founder. By the end of 2020, Nikola's stock had lost much of its value, illustrating the uncertainty and risks tied to investing in SPACs. Investors who bought in early faced significant losses as the company's challenges became public.
SPACs can offer significant upside, but it's essential to understand the inherent risks before committing your funds.
Real Estate
Real estate has long been a go-to alternative investment, offering multiple avenues for profit. Some investors opt for residential or commercial rental properties, while others look to flip houses for a quicker return.
Owning real estate can provide passive income through rent and act as a hedge against inflation, as property values typically increase over time.
However, real estate requires a significant initial investment and can involve ongoing expenses, such as property maintenance, taxes, and dealing with tenants.
Real estate investment trusts (REITs) can offer a way to invest in real estate without the responsibilities of owning and managing properties. REITs are publicly traded on exchanges and offer the benefit of liquidity, as well as dividend payouts.
While REITs make real estate investing more accessible, they can be subject to volatility, especially in times of rising interest rates or economic downturns.
Commodities
Commodities like crude oil, natural gas, precious metals, and agricultural products offer another avenue for alternative investment. These tangible assets can serve as an inflation hedge, as their prices tend to rise when inflation increases. For instance, oil and agricultural products often see price hikes during periods of economic uncertainty or supply chain disruptions.
Investing directly in commodities can be complex, but commodity ETFs have made it easier for individual investors to gain exposure. These funds track the price movements of a specific commodity or a basket of commodities, allowing you to benefit from price changes without needing to buy the physical asset.
While commodities can diversify your portfolio, they're also known for their volatility. Prices can be affected by geopolitical events, weather conditions, and changes in supply and demand.
For example, during the COVID-19 pandemic in 2020, the price of crude oil plummeted to unprecedented lows, even turning negative at one point due to a combination of geopolitical factors and a sudden drop in demand. Global lockdowns severely reduced travel, slashing the demand for oil. At the same time, a price war between major oil producers Saudi Arabia and Russia contributed to oversupply, exacerbating the crash.
Conversely, agricultural commodities like wheat and soybeans saw price spikes as weather conditions impacted crop yields, and pandemic-related disruptions affected supply chains. This demonstrates how external factors such as global politics and natural events can create significant price swings in commodities, affecting their stability as investments.
Risks to Keep in Mind
While alternative investments can provide portfolio diversification and growth, they also come with a unique set of risks:
- Liquidity Risk: Many alternative assets, such as real estate or private equity, don't have a readily available market. This makes it challenging to sell quickly if you need access to cash.
- Valuation Risk: Pricing alternative investments can be tricky since they aren't always traded publicly. For instance, valuing art or privately held companies can be more subjective and harder to track than stocks or bonds with transparent pricing.
- Regulation Risk: Alternatives are generally less regulated, increasing the possibility of fraud or mismanagement. Additionally, many of these investments are only available to accredited investors, making them less accessible to the average person.
- Market Risk: Fewer buyers and sellers mean that the markets for alternative investments are often smaller and less liquid. This can affect the timing and the price at which you can exit the investment.
It's essential to weigh these risks against your risk tolerance and long-term objectives before making any decisions.
Conclusion
Alternative investments can help reduce risk and may increase returns in your portfolio through a diverse range of opportunities.
From the stability of gold to the fast-moving world of cryptocurrencies and the income potential of real estate, these investments can complement traditional assets. However, they come with their own set of risks, including liquidity, valuation, and regulatory uncertainties.
Before diving into alternative investments, ensure they align with your risk tolerance and your financial planning roadmap. If you don’t currently have a financial roadmap, that should be your first step. A well-researched strategy can help you take advantage of these opportunities while effectively managing the risks.
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