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Alternative investments have the capability to offset market volatility and inflation by diversifying your portfolio beyond traditional investment classes like stocks and bonds. While they come with risk like any investment, alternative investments aren’t tied to the performance of the stock or bond markets, so they’re especially attractive during times of increased market volatility.

In this article, you’ll find:

  • The definition of alternative investments
  • Types of alternative investments
  • The pros and cons of alternative investments
  • How to invest in alternative investments
  • Tax implications

What Are Alternative Investments?

Alternative investments are investments outside traditional categories like stocks, bonds, and cash. They cover a wide range of assets, such as hedge funds, private equity, and real estate. Though they may be risky, they can also give you an important hedge against market volatility and inflation.
alternative investments

Alternative assets, like real estate or collectibles, often require more money to get started. They’re also generally less liquid. For instance, it’s harder to sell a niche item like a vintage ‘57 Chevy than to convert 500 shares of an index-linked fund to cash. It can be tougher to value these assets too— it’s no mean feat to set a price for a signed Michael Jordan rookie-year basketball jersey. (If you have one for sale, let us know.)

Despite these issues, the demand for alternative investments is increasing, thanks to their potential to protect against volatility and deliver high returns.

Types of Alternative Investments

There are several kinds of alternative investments, including real estate, hedge funds, private equity, timberland, and commodities. Some investors also buy collectibles like art, wine, or rare coins. Cryptocurrencies like Bitcoin are alternative investments too, as are private debt and infrastructure.

1. Real Estate

Real estate investment has two potential benefits. The first is that it can grow its value over time. The second is that it can generate regular, passive rental income. Investors who have less starting capital can still invest in real estate investment trusts (REITs) and funds like CalTier. Real estate can offer tax advantages too, including deductions on mortgage interest, property taxes, and depreciation.

2. Hedge Funds

Hedge funds can make big gains thanks to their active, research-backed portfolio management. They’re known for being flexible, but they can charge high fees and require significant minimum investments. Even so, their performance-based fee structure keeps their managers focused on growing wealth.

3. Private Equity

Private equity is a direct investment into non-publicly traded companies, including startups and established businesses. Investors realize returns through “exits” such as initial public offerings (IPOs) or sales to other private investors. Two drawbacks here are the long holding periods and higher capital costs.

4. Commodities

Commodities are physical goods like gold, silver, crude oil, corn, and soy. Their prices rise and fall based on supply and demand. Investors can buy commodities directly, through futures contracts, or through exchange-traded funds (ETFs). Commodities trading is often best left to experienced investors who understand the market.

5. Venture Capital

Venture capital is a subset of private equity that funds startups in exchange for equity. This high-risk alternative investment targets innovative companies that have significant growth potential. (Google at the ground floor, anyone?) Venture capital investors (VCs) are often successful startup founders themselves. They bring their experience to the table, helping startups grow by offering mentorship and other resources to founders.

6. Collectibles

Collectibles are rare items like art, vintage wines, coins, NFTs, stamps, classic cars, and memorabilia. Their value can increase with time based on their on limited availability or popularity. Though the returns can be high, the value of collectibles is often unpredictable. Successful collectibles investors usually have deep experience with niche markets, too. For instance, a wine connoisseur might start a wine collection, or a literature buff might buy rare folios.

7. Cryptocurrencies

Cryptocurrencies are digital or virtual currencies based on blockchain tech. This relatively new asset class includes Bitcoin and Ethereum. Like the other alternative investments on this list, they can deliver high returns, but fluctuating popularity and regulatory uncertainty makemakes them a high-risk choice.

8. Private Debt

Private debt lends money to companies outside of traditional bank loans or markets. It offers fixed returns, high yields, and a higher risk than public debt. The market for private debt has grown significantly since 2022, mostly thanks to volatility in the stock market. Private debt can include direct loans, mezzanine financing, and distressed debt.

9. Infrastructure

Infrastructure investors lend money to fund transportation (roads, airports), utilities (water, electricity), and telecommunications. They earn stable, long-term returns, thanks to consistent, inflation-linked cash flows from user fees or government contracts. They can take a long time to generate returns, though one exception is infrastructure ETFs.

10. Timberland

Timberland investors put money into the management of commercial timber. The returns here are long-term, based on the growth of trees, the sale of timber, and land appreciation. Though the average investor won’t usually buy a tract of timberland in Oregon or Canada directly, there are exchange-traded funds that sell shares in these investments.

Pros and Cons of Alternative Investments

Alternative investments can help diversify your portfolio and generate high returns, but they can carry more risk and lower your liquidity.

Pros:

  1. Diversification
  2. Inflation Hedge
  3. High Return Potential
  4. Income Generation
  5. Tax Benefits
  6. Innovation and Growth
  7. Portfolio Flexibility
  8. Exclusive Opportunities

Cons:

  1. High Entry Barrier
  2. Liquidity Issues
  3. Complexity
  4. Higher Fees
  5. Regulatory Risks
  6. Market Volatility
  7. Limited Historical Data
  8. Long-Term Commitment
  9. Valuation Challenges

Pros of Alternative Investments

The main attractions of alternative investments are their high-return potential and their insulation from economic downturns. For instance, real estate prices often rise and fall independently of stocks. Protection from inflation is another key advantage. An investment in an Airbnb in Maine or commodities like gold or oil can hold value during periods of high inflation.

Some alternative investments, like venture capital, let investors share the profits of tech startups. A stake in a successful company like SpaceX or Uber in their early days can deliver exponential returns, far surpassing those in more traditional investment vehicles.

Investments like private debt, rental properties, or dividend-paying real estate investment trusts (REITs) can also generate passive income.

Cons of Alternative Investments

Alternative investments can have higher upfront costs. For instance, it costs significantly more to buy a rental home in Illinois than a small amount of common stock.

The complexity of alternative investments can be another disadvantage. Successful investments in hedge funds or timberland can use sophisticated strategies that are difficult for non-professionals to understand. This can damage your returns. Some hedge funds, for example, use a “2 and 20” fee structure (2% management fee and 20% of profits).

It can be harder to sell alternative investments, too, since there are fewer buyers for rare items like an Air Jordan 11 “Concord” or a 50% stake in a new online business.

Regulation and market volatility are still other disadvantages. Cryptocurrency prices can shoot up suddenly based on new laws or the latest viral video. Similarly, new SEC rules can negatively impact hedge funds or private debt investments.

How to Invest in Alternative Investments

There are as many different ways to invest in alternative investments as there are types of those investments. Investing in real estate is a very different prospect from buying works of art or hedge fund shares.

1. Real Estate

Direct investment in apartment buildings or vacation homes requires a large amount of capital up front. However, you can cut your investment down to size by buying shares of real estate investment trusts (REITs). REITs are liquid, generally high-yield, and can let the average investor earn money on commercial properties and dividends.

2. Hedge Funds

Often you have to be an accredited investor or an institutional investor to invest in hedge funds. For individuals, that means having a net worth of at least $1,000,000 — not including your primary residence. You’ll also need an income of over $200,000, or $300,000 if you’re married. Many hedge funds also require a minimum investment of $25,000, all the way up to $1 million or more for the most lucrative funds, like Berkshire Hathaway or D.E. Shaw.

3. Private Equity

Often, only accredited investors can invest in private equity. Private equity investors spend a lot of time finding the right private equity firm and researching their historical performance and management team. They typically wait years to see returns while the companies they’ve invested in gain market share.

4. Commodities

Average investors can buy commodities like gold or oil directly, but since that can be impractical, most investors buy commodities through futures contracts or shares in commodity-producing companies or ETFs. You can also buy shares of certain mutual funds and hedge funds that trade on natural gas, corn, silver, or soybeans.

5. Venture Capital

The revised Jump Start Our Business Startups Act in 2015 allowed ordinary investors to participate in venture capital through crowdfunding. This regulatory change sparked several new venture capital platforms for non-accredited investors. Be warned that since 80% to 90% of startups fail in the first year, venture capital investing can be very risky.

6. Collectibles (e.g., art, wine, coins)

Owning collectibles can give you a double benefit. The first is that you’ll enjoy owning and appreciating your item, whether it’s a bottle of Dom Perignon from 1953, or an original Picasso that you picked up at an auction. The second is that your collectible stands a good chance of selling later for more money than you paid for it. However, the collectibles market can be uncertain, and they may be hard to offload when you’re ready to sell. Also, it pays to be an expert on the type of collectible you’re interested in buying.

7. Cryptocurrencies

The cryptocurrency market is notorious for mixing high risk with the possibility of a high return. Before you divedip into this alternative investment, take the time to learn about blockchain technology and current market trends and regulations.

Read up on each currency’s popularity and effectiveness, and be prepared for sudden market shifts that can shock your holdings overnight.

 

8. Private Debt

You can invest in private debt by buying shares in private debt funds. These give companies a fundraising alternative to selling public stock and bonds. Since private debt is usually used by companies that can’t get funding any other way, it’s generally a very risky type of alternative investment.

9. Infrastructure

Since most investors can’t directly invest in toll roads, bridges, and renewable energy projects, infrastructure investment generally happens through dedicated infrastructure investment funds. The average investor should start by contacting a brokerage and researching funds.

10. Timberland

Individual investors can invest in timberland by buying shares in publicly traded timber REITs and ETFs. Larger, institutional investors can invest via Timber Investment Management Organizations (TIMOs). Like trees, the value of timberland generally grows steadily over time, though it’s vulnerable to changes in the price of lumber, and to natural disasters.

Tax Implications of Alternative Investments

Each alternative investment vehicle above has its own unique tax implications. For example, pass-through entities like partnerships can subject investors to personal income tax. Meanwhile, real estate has tax benefits like deductions for depreciation and property tax.

Investors can cut their tax costs with insurance dedicated funds (IDFs) or tax-advantaged accounts like IRAs. You can also use 1031 exchanges for real estate investments or installment sales to defer capital gains.

Given the complexity of tax laws and the individual nature of tax planning, It’s important to consult a tax professional before you buy alternative investments. You’ll get personalized guidance and keep more of your returns.

Diversify Your Investments With CalTier

CalTier is an innovative online investment and technology platform that lets investors gain access to earn returns from typically hard to reach institutional gradeexclusive alternative investments like multi-family real estate investments. With CalTier, you’ll benefit from a diverse portfolio of cash-flowing apartment complexes spread throughout the U.S., plus open access to both non-accredited and accredited investors.

Enjoy low fees to maximize your returns and generate consistent cash flow, no lock in periods, plus redemption flexibility and the opportunity to diversify your portfolio, providing you with short and long-term options.

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