Financial advisors are as diverse in their investment styles as mutual funds. Funds can range from conservative fixed income portfolios that protect capital to leveraged ETFs that amplify the ups and downs of broad market indexes. Likewise, advisors can keep their recommendations limited to varying allocations of the traditional asset classes such as stocks, bonds, and cash — or they can employ more complex portfolio strategies involving alternative assets. The most effective financial advisors are those who can play either role, depending on the client’s investment timeline, risk tolerance, and financial situation. That’s because no one portfolio type or asset allocation is appropriate for every investor. Financial advisors who understand the full range of investments, including alternative investments, are better prepared to develop personalized wealth plans for all of their clients, from the conservative to the risk tolerant. Here’s a closer look at what alternative investments are, how they work, and which alternative asset types are most popular among investors who are new to this space.
What are alternative investments?
Alternative investments are assets purchased for price appreciation or income that do not fall into the standard categories of stocks, bonds, or cash. Real estate is the best-known alternative asset, but there is a huge range of other, lesser-known asset types that may have a role to play in your clients’ portfolios. The options range from tangible assets like classic cars or fine art to financial assets such as cryptocurrencies and venture capital. Each type of alternative investment has unique characteristics, in terms of how the asset’s value behaves relative to economic and financial market trends. For that reason, alternative investments are often used to refine the behavior of an investor’s overall portfolio and insulate wealth from broader issues like systemic financial crisis.What are the benefits and risks of alternative investments?
Alternative investments can be lucrative, but they’re not for the faint of heart or for the hands-off investor. They’re better suited for the individual who understands and accepts the benefits and trade-offs associated with these non-traditional asset types.Benefits of alternative investments
Specific alternative assets have their own unique advantages. Gold, for example, is often used as a hedge against inflation. But there are also benefits that apply to alternative assets as a whole.- Asset diversification: Alternative assets have a low correlation to the financial markets. They may hold their value or even increase in value during a bear market, for example. That’s useful from a diversification standpoint; wealth invested in alternatives is somewhat sheltered from being degraded by macro trends.
- Ability to invest using tax-efficient accounts: Many alternative assets can be held within a self-directed IRA, which offers tax-free contributions and tax-deferred earnings growth. Specifically, retirement savers can hold investment property, livestock, bitcoin, tax lien certificates, mineral rights, and other niche investment types in a self-directed IRA.
- Option to invest in personal interests: Alternative investments can be far more interesting than shares of Walmart or Amazon. Your clients who have a personal interest in classic cars, wine, racehorses, or even certain types of innovation may find it incredibly rewarding to invest directly in those interests.
Risks of alternative investments
As with the benefits, there are risks that apply to both individual asset types and the category of alternatives as a whole. Here are three of the broader issues your clients might face when investing in alternatives:- Can be higher risk: Alternative investments are often less predictable and more volatile than traditional stocks and bonds. Still, many investors are willing to accept the higher risk for the potential of a steeper growth trajectory.
- Lack of pricing transparency: Many alternative investments are not exchange-traded, which means those assets are not being continually repriced according to supply and demand. Investors therefore will have less ongoing visibility into the asset’s market value.
- Less liquidity: Alternative assets are generally less liquid than stocks or bonds. Investors may need to hold alternative assets for long periods of time before seeing any return.
Types of alternative investments
There’s no single, exhaustive list of alternative investment examples. That’s mainly because the category is constantly expanding by way of cryptocurrencies and new crowdfunding platforms like MasterWorks, Rally Rd, Prosper, and MyRacehorse. However, the investor looking to break into alternative investments for the first time is probably best suited for more mature alternatives anyway. Seven of the more common alternative investment ideas are introduced below.Private Equity