Table of Contents
When it comes to investing…
When it comes to investing, people tend to prefer stocks and bonds. These traditional investments have their merits, but they are not always as diverse an investment as the investor might want them to be. That’s where alternative investments come in— they can help increase the diversity of your portfolio and may increase your returns. In this article, we will discuss various alternative investment products available as opposed to the conventional stocks and bonds and the opportunities and risks that come with each.
What are Alternative Investments?
Alternative investments include assets that are not in the form of conventional assets, that is, stocks, bonds or cash. This category includes a wide spectrum of investments, including real estate, commodities, hedge funds, private equity, and many others. The advantage of alternative investments is that they are relatively insensitive to traditional assets, which means that their prices are not affected by the regular market fluctuations.
Advantages of Alternative Investments
1. Diversity: One of the greatest advantages of alternative investments is the ability to increase the variety of your investment portfolio. This allows you to prevent the assets that you invest in from being correlated with those of traditional investments, which may lead to reduction of risks and enhancement of the chances of receiving profits.
2. Possible to Get Higher Returns: Some of the alternative investments are known to provide returns that are higher than those of the traditional investments. For instance, real estate can generate income from rental yields and capital growth, while private equity can offer high returns through capital appreciation.
3. Protection Against Inflation: Some of the alternative investments including commodities and real estate have in the past been use to counter inflation. As these asset values usually rise with inflation, they can help to maintain the value of your portfolio purchases.
Risks of Alternative Investments
1. Illiquidity: A major drawback of many alternative investments is that they have lower levels of liquidity as compared to stocks and bonds. The process of selling a real estate investment or withdrawing from a private equity fund may take some time and it may be difficult to get your funds quickly when you need them.
2. Volatility: It is also a fact that alternative investments can be more volatile than the traditional investments. For example, the price of commodities is determined by factors such as supply and demand, political issues and climate conditions among others. This results in more price changes and therefore more risk.
3. Complexity: Alternative investments can also be more complicated to understand than traditional investments. Some of these options include hedge funds or private equity which employ complicated strategies and structures that may not be appropriate for all investors.
Types of Alternative Investments
1. Real Estate
Real estate is one of the most popular alternative investments that can provide both income and appreciation in the value of the asset. Investors can directly acquire properties or invest through real estate investment trusts (REITs), which own and manage income-producing properties and provide a means of participating in real estate investments without actual property ownership.
Example: John wants to diversify his investments, so he buys a commercial building and leases it. He receives the rent and expects the property to appreciate in value over time.
2. Commodities
Commodities are another type of alternative investment that can help to reduce the risk of a portfolio and also serve as a hedge against inflation. This category includes physical goods, such as gold, silver, oil, natural gas, and agricultural products. These can be bought through futures contracts, ETFs or by investing in companies that produce these commodities.
Example: In view of the rising inflation, Sarah decides to invest in gold, a commodity that is commonly used as a store of value during inflationary regimes. She decides to buy gold bullion and keep it in a safe deposit box.
3. Hedge Funds
Hedge funds are investment vehicles that are funded by accredited investors in order to employ various strategies in order to create returns. They employ long/short equity, global macro, and event driven strategies among others. The attractiveness of hedge funds is that they are relatively adaptable such that they can make profits in bullish as well as bearish markets.
Example: Mark, a high net worth individual, invests in a hedge fund that has global macro as its investment strategy. The fund manager makes their investments based on the analysis of the world’s economy and political environment, thus enabling Mark to earn returns irrespective of the market direction.
4. Private Equity
Private equity is the investment in companies that are not publicly listed and are therefore not traded in the stock market. This type of investment is most attractive to investors who are interested in companies with potential for growth and development over the long term. Private equity investments are typically illiquid and thus require a good degree of tolerance.
Example: Emily is a venture capitalist who puts her money into a private equity fund that focuses on the early stage technology companies. In return for the money, the fund takes a part of the ownership – it could be a great return if the startups become successful in the future.
Conclusion
Stocks and bonds are essential in a diversification strategy, but alternative investments open up other opportunities for diversification and perhaps higher returns. Other opportunities include real estate, commodities, hedge funds and private equity. However, there are some specific risks that are associated with these investments, such as lack of liquidity, higher levels of risk, and difficulty in comprehension. It is important to research and understand the market before investing in alternative investments in order to achieve higher returns and minimize risk in the long run.
