Investors frequently hear warnings of the perils of not diversifying their portfolios between stocks and bonds. While certainly two major asset classes you should consider when learning how to start investing money, other investment opportunities exist beyond traditional exchange-listed securities.
In fact, a truly diversified investment portfolio should also include “alternative investments.” By definition, these represent financial assets which do not fall into either of these conventional asset classes. For example, alternative investments include tangible assets like art, wine, gold, oil, real estate (like condos, single-family homes, commercial real estate, etc.), venture capital, royalties, tax liens, and much more.
In their truest sense, alternative investments represent a further diversification in your portfolio and often act as a buffer against volatility seen in the actively-traded securities like stocks and bonds. When it comes to choosing which alternative investment options make sense for your portfolio, you should consider:
- their liquidity (i.e., how quickly and cheaply these assets can convert to cash if you need to sell),
- how they fit into your budget,
- investing time horizon (and patience level), and
Before discussing several examples of alternative investments you should consider, let’s first examine the primary pros and cons of investing in alternative assets in this Alternative Investments 101 guide.
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Pros of Alternative Investments
As mentioned briefly above, alternative investments carry a number of positive elements for why you should consider making them part of your overall strategy on how to build wealth. Read below to see the primary reasons for including alternative investments in your portfolio and also keep in mind the various details related to each alternative investment differ. Therefore, not all of these elements will apply in each situation.
First and foremost, holding a diverse selection of assets decreases the likelihood of taking on asset-specific risk. Holding multiple types of assets reduces the possibility of exposing yourself to the risk of one investment adversely impacting your overall portfolio return. Many investors turn to alternatives as a way to create a more diverse portfolio rather than having everything wrapped up in stocks, bonds, and cash.
→ Higher Potential Expected Returns
Given the long-term nature of many alternative investments, their illiquidity offers a premium investors expect in exchange for losing immediate access to their funds. For the disciplined, long-term oriented investors, some alternative investments appear attractive simply because they offer higher expected returns which might not come from other investing strategies.
→ Not Correlated with the Stock or Bond Markets
Depending on the alternative investments considered, some do not have significant (if any) correlation with the stock or bond markets (at least directly). In other words, changes in the stock market should not directly affect the value of your alternative investment. Translation: alternatives can act as a valuable portfolio diversifier due to their potential for insulating your portfolio from day-to-day volatility during rough market conditions.
→ Tax Benefits
Alternatives vary with investment objective and return potential. Some provide income streams while others offer capital appreciation opportunities. Depending on the alternative considered, they may act as tax-advantaged investments worth examining in your evaluation. If you have uncertainty about their tax consequences, please consult a tax professional for advice related to your personal situation and the specific investments under consideration.
Cons of Alternative Investments
Now that we have examined the main reasons for why you would consider investing in alternatives, let’s also take a moment to address some of their drawbacks.
→ Risk of Loss
Every investment carries some level of associated risk. Alternative investments act no differently. Therefore, while the level of risk will vary from one investment to another, in general, alternative investments still carry risk.
Depending on the type of alternative asset, they may range in risk from conservative to aggressive. One other item to consider during your analysis are regulations or the lack thereof. While traditional investments like investing in index funds, stocks and bonds have deep markets and tightly-controlled rules and regulations (even something as risky as shorting stocks on Robinhood and Webull comes with strict rules and regulations), not all alternative investments come with such certainty.
As a result, rules and regulations will vary by investment and should factor into your risk evaluation. Investing in alternatives carries the risk of partial or complete loss in some instances.
→ Unfamiliar Assets and Risks
A major reason why alternative investments can carry more risk than more traditional investments stems from the fact that they tend to be less familiar to most investors.
As a general rule, you should avoid investing in anything you do not fully comprehend (e.g., credit default swaps).
Therefore, take time to conduct your own research into the asset before moving forward with an alternative investment. If you choose to invest without sufficient due diligence, you could potentially expose yourself to an undue amount of risk.
→ Tax Disadvantages / Complexity
Just as some alternative investments create potential for tax-advantaged investments, the same applies to the other side of the coin. Some alternatives offer tax disadvantages compared to other options available to you. As a result, you should consider speaking with a tax professional if you do not have certainty about the tax consequences of investing in an alternative investment.
→ Some Alternative Investments Require a High Minimum Investment
As with all investments, certain minimums could apply. Mutual funds, target date funds, and other common types of investment vehicles often present hurdles in the form of minimum initial contributions before gaining access to investing in their funds. While index funds on Robinhood or the best Robinhood alternatives do not require minimum investments (beyond affording the price of purchasing one share), alternatives present different rules in some cases.
Some platforms present minimum investment thresholds before allowing you to invest in their asset, platform or service. Despite these hurdles, some of the alternatives addressed later in this article do not require a lot of money to start investing. Options exist for everyone, but the more money you have, the more likely you are to have access to invest in more assets.
→ Some Alternative Investments Options are for High Net Worth Individuals Only
Some investments only allow access to accredited investors, or those meeting certain net worth or annual income thresholds. Therefore, some alternative investments are only open to high net worth individuals.
In broad strokes, two types of investors exist in the eyes of the U.S. regulators: accredited and non-accredited. From purely a numbers perspective, accredited investors have more investment options than non-accredited investors, all things being equal.
As a specific call out: a handful of these services mentioned below only allow access to accredited investors (or those people who meet one or both of the following criteria):
- Earned income in excess of $200,000 (or $300,000 if married) for each of the last two years with reasonable expectations for that amount this year, OR
- Have over $1,000,000 in net worth (with or without a spouse), excluding the equity in a primary residence
Again, the details of each investment will vary, but several investments covered in this article tend to only have access available to accredited investors. Therefore, this means only a small percentage of people will have access to pursue those investments.
Famed quantitative-focused investor Cliff Asness speaks highly of “liquid alts,” or those alternative investments readily convertible to cash within a reasonable period of time. In Asness’ view, a well-constructed portfolio which includes liquid alts can help investors diversify their portfolios and — eventually — reap long-term gains.
He argues for this strategy to work effectively, the alternative investments should have low correlation to traditional assets, such as stocks and bonds, which trade at expensive levels compared to historical valuations.
As a result, if you can find diversifying, positive expected return “liquid alts,” then you can materially improve your portfolio. Therefore, let’s take a look at some alternative investments which might diversify your portfolio.
1. Invest in Fine Wine with Vinovest
Buying expensive wines may be one of your favorite activities, but did you know it could make you money? As a tangible asset, wine has a low correlation with global equities and has less long-term market volatility than other investments.
Because wine comes from specific regions in finite quantities, the supply does not fluctuate much.
As people consume the wine, the supply diminishes and the demand increases. Simple Economics 101. As a result, this makes it an excellent alternative investment option.
Plus, as a worst-case scenario, you can drink your wine! This may sound tempting to buy your own wine, store it in your basement, and hope for the best.
However, if you really want to make a profit, there are benefits to using a company to build your wine investment portfolio, such as Vinovest. Fine wine dramatically outperformed several asset classes during the Great Recession and likely will during the COVID-19 bear market cycle.
The minimum balance for Vinovest is $1,000 and you pay a 2.85% annual fee to cover labor, storage, authenticity guarantee, portfolio rebalancing, and insurance. You can lower your annual fee to 2.5%, as well as get one-on-one expert guidance and extra rare wines, if your minimum balance is $50,000 or greater.
Consider the long-term potential growth in value of this investment and look more into the investment potential. You might find the lack of volatility and consistent returns as reasons for why fine wine investing might be one of the best investments for young adults.
2. Invest in “Blue-Chip” Art Investment Company Masterworks
“Blue-chip” refers to well-established art and artists with high aesthetic quality. Long-term, fine art has shown to be a reliable and lucrative investment. However, multi-million dollar artwork is typically only an investment available to the extremely wealthy.
Times change, however. Now, the art investment company Masterworks has made blue-chip art investments possible for more people than ever by allowing people to open an account with an account minimum as low as $1,000 to purchase fractional interests in expensive pieces of art. Therefore, this makes world famous art affordable to invest in for your portfolio.
If approved after the application process, you can buy partial ownership of artwork created by famous artists such as Andy Warhol, Claude Monet, Banksy, and more. The Masterworks team has over 75 years of collective experience as dealers, collectors, or working for auction houses.
They look at a database of over a million auction records and choose artists based on risk profiles and appreciation. Even then, there are significant financial risks.
Once they have purchased a painting, they file an offering circular with the Securities and Exchange Commission, which gives you certain rights under securities laws in the United States.
Masterworks actively tries to sell paintings at a gain for their investors. They also seek ways to provide liquidity for investors, such as by sometimes making it possible to sell your shares to other investors.
Fees charged include a 1.5% annual management fee as well as 20% of the profit if the painting increases in value. Investing in art shares might not act as a good fit for anyone who does not feel comfortable with an illiquid investment.
Because it can take years for the asset to appreciate and sell for a gain, the money might take years to see a significant return, if any. This investment is best fit for people passionate about art who do not expect speedy returns.
3. Invest in Personal Loans With LendingClub or Reddit
LendingClub encourages you to “invest in people” as opposed to investing in yourself only. LendingClub’s Note platform has a low correlation to the stock market, 4-7% historical returns, and has a minimum of only $1,000 to get started. Not a bad way to make money while you sleep.
You spread your risk out across several borrower loans, adding limited exposure to any one loan. As a means for protecting yourself from too much risk, you can purchase notes in increments as low as $25 to diversify the effect of only investing in one personal loan.
Investors have the option of automated investing or to have more control and set filters for themselves on which loans to target for investing.
Some filter examples include:
- Credit score
- Loan purpose
- Debt-to-income ratio
- Monthly income
- Number of accounts in delinquency
- Inquiries on credit report in last 6 months
The notes you purchase do not directly come from the borrower. Instead, you invest in Member Payment Dependent Notes (sometimes referred to as just “Notes”) which connect to fractions of loans.
Lower-grade notes (lower credit quality) come with higher interest rates because of the risk involved with investing in borrowers with weaker credit histories.
Unlike with the majority of fixed income securities, you do not have to wait until maturity to get some of your principal back. Borrowers make monthly payments, over three to five years (unless they pay ahead), on both principal and interest.
In fact, in my personal experience, when interest rates decrease, some borrowers use the opportunity to secure a second LendingClub loan and use those proceeds to repay the existing loan. In essence, they refinance the loans, providing them a better rate and you with liquidity.
In the event of a default, LendingClub works to collect late or delinquent payments. LendingClub takes out fees and deposits your share into your account.
Your net return is the average interest rate corresponding to your Notes portfolio, after losses and fees. To make everything easier, you can manage your account from their free mobile app.
If you like the idea of personal loans, but find LendingClub’s process too complicated, another option is to provide personal loans on Reddit. The subreddit r/borrow has been matching users who need a loan with lenders since 2011.
Typically annualized interest rates range between 10% to 25% and are paid back over a course of weeks or months. Most loans range between $100 to several thousand.
The benefit to using Reddit is the simplicity, but the downside is the lack of contracts or collateral. People who want more security are better off using a service like LendingClub.
4. Collateralized P2P Loans with Constant
Of particular importance is the following: No investors have lost their principal since Constant launched in early 2019. If this sounds like an alternative investment of interest, consider opening an account for as little as $50 to see if it aligns with your investment objectives.
When you open an account and make an initial deposit, you’ll receive a ~$7 bonus as an added incentive for opening and funding your account. To learn more about the service, consider reading our Constant review.
5. Invest in Crowdsourced Real Estate With FundRise
“Buy land, they’re not making anymore.” -Mark Twain
Commercial real estate creates a steady income from rent and property value typically increases over time. The initial investment minimum on FundRise is only $500 for the lowest level and the main requirements are just to be a U.S. resident aged 18 or older.
The first step is to get financing and buy or build a commercial real estate property. The options have been carefully picked for the best chance of growing your net worth.
In the next step, the investor leases space in the property to people who pay rent. Once covering the expenses, the rest of the rental income acts as profit.
In the final step, the investor can choose to sell the property.
FundRise charges 0.15% in annual advisory fees for managing your account, but you can have these fees waived when you refer friends who join. There is also a 0.85% charge in annual management fees for managing the real estate funds, the eFunds and eREITs that make up a portfolio. Some projects may have development or liquidation fees.
In some cases, the passive income tax rates make these investments advantageous compared to other investment income.
These act as highly illiquid investments, so only invest if you want to consider a longer-term investment. For many, the benefits of low fees and a low minimum investment make up for the illiquidity.
While no investment comes 100% safe, real estate is considered one of the safer investment options for diversifying one’s portfolio. FundRise boasts 8.7% – 12.4% historic annual returns. The passive income from real estate investing can be a good source of supplemental income to consider.
6. Mineral Rights and Royalties
In the United States, land often comes paired with the right to any minerals produced on the property or beneath it. People commonly refer to these natural resource claims as “mineral rights.”
In an instance where an exploration and production company wishes to drill in your area and it could potentially result in oil and gas production, you have a right to that bonus and income. The drilling company, or another investor, would have ownership of the working interest in the well.
In my first job, I worked to secure mineral rights from landowners who lived above oil and gas fields across the country. The company identified hot spots across the country and approached landowners who wished to sell their future stream of income payments for a discounted lump sum. My firm had patient capital from investors who wished to park their money in these properties for the long-term.
Initially, my focus centered on income-producing assets, or properties already generating income from oil and gas wells. However, with time, my firm decided to begin diversifying into proven but non-producing properties to provide potential upside to the portfolio in the long-term.
And upside did that decision provide. The firm’s portfolio quadrupled in value in only 18 months by adding these properties which did not produce any resources at the time of purchase. Risk surely came along with this upside because no guarantees existed the oil and gas would come out at economic levels.
Many companies exist looking to purchase mineral rights for any kind of natural resource found on land. You might have the opportunity to use your networking tips to buy into one of these firms or invest in a pool of capital if you trust the company to operate prudently. Research the companies’ leadership philosophies, their investment objectives, and how their performance has fared in the past before proceeding with investing.
7. Life Insurance Settlements
Life insurance settlements, commonly referred to as “life settlements,” comes as a rarer type of alternative investment. Understandably, this requires a stronger stomach not only to discuss, but to consider choosing as an alternative investment. Why? Because you want to purchase life insurance policies of people who will die soon at a discounted amount.
More specifically, the mechanics work like this: life settlements involve someone selling their life insurance policy to you for a discount about the face value. Typically, the investor pays more than the cash surrender value (if whole life) but less than the death benefit value of the policy (whether whole life, term life insurance or another type of life insurance). After life settlement transaction occurs, the investor continues to pay premiums on the policy and then collects the benefit after the insured’s death.
For historical context, these investments carry inherent risk from the insured person living beyond life expectations. These products gained notoriety during the 1980s and 1990s when the HIV/AIDS epidemic took the lives of many in the gay community across the United States. However, with recent advances in medical science, these life settlements have not performed as well as expected.
Despite this risk, funds exist that manage investments in life settlements. In many cases, the appeal of this investment comes from three primary advantages:
- Strong historical returns
- Low risk compared to the relatively high potential for gains
- Non-correlated with the stock market
8. Invest in Start-Ups and Private Companies
If you have been tuned into the investing world for any significant amount of time, you have probably heard of the fabulous wealth created by investors who struck it rich by investing in the next big company. People like Ashton Kutcher who invested in Uber, AirBnb and many others tech unicorns before they created new platforms millions use on a daily basis.
However, you’ve also likely heard of people who invested in failed companies like Theranos and now face dismal financial straits. In the world of start-up investing, your investments are “either home runs or [strikeouts],” New York-based securities lawyer Gregory Sichenzia told U.S. News recently. Because of this binary set of boom or bust investing outcomes, anyone who chooses to invest in start-ups should be aware that losing all of their investment has a high likelihood.
In 2012, President Obama signed a law loosening the restrictions placed on crowdfunding for startups and directly in private companies. Some platforms, like NextSeed, allow access to both accredited and non-accredited investors to invest in pre-vetted businesses and start ups from around the country.
The risks and rewards you can expect to receive align with the investment stage of the company you select through the NextSeed platform. In other words, if you choose to invest in the seed round for a company’s financing you have a higher likelihood to lose your entire investment while a larger opportunity to strike it rich.
Conversely, if you invest at a later stage round of investing, you can expect less risk and return than a comparable early stage investment. Because vetting startups is a difficult task, companies like NextSeed have sought to bridge this gap by helping small investors find investment opportunities in startups.
NextSeed provides two primary investment options like revenue-sharing notes, or an agreement the business will pay you a percentage of their monthly revenue until you receive the total repayment amount or term notes (essentially a business loan with a fixed interest rate repaid in an agreed amount of time.
As with most options included on this list alternative investments, your money will be tied up in this startup investment for a longer period of time. This, combined with the risk of investing in a startup should be weighed if you choose to invest.
Sign up for an account (no obligation to invest) to learn more about the alternative investment option.
How Much Should You Invest in Alternatives?
After reviewing some major details about alternative investments and reviewed some alternative options, you might still wonder, “How much should I invest in alternatives?” As with all things investing-related, the answer will depend on several different variables.
Alternative investments help to protect you against a market crash, have high potential returns, and many tend to have less volatility than some traditional investments. Today, many investment opportunities that used to be reserved only for the very wealthy are available to people with more moderate amounts of money to invest.
If you want to diversify your portfolio and are considering alternative investments, decide carefully what the best option(s) for you are. You may choose to try out a few investments for even more diversification. Just make sure never to invest more than you can afford.
Financial advice varies, but a common amount to consider for your overall portfolio is around 10%.
Finally, you should also remember that “alternative investments” comprises a very broad term. Many of these investments have little to no correlation with each other or with other traditional investments. Following Asness’ advice, you want liquid alts which can provide positive, non-market correlated returns. Whichever allocation you feel accomplishes this amount for you successfully would be your suggested allocation to alternative investments.
About the Site Author and Blog
In 2018, I was winding down a stint in investor relations and found myself newly equipped with a CPA, added insight on how investors behave in markets, and a load of free time. My job routinely required extended work hours, complex assignments, and tight deadlines. Seeking to maintain my momentum, I wanted to chase something ambitious.
I chose to start this financial independence blog as my next step, recognizing both the challenge and opportunity. I launched the site with encouragement from my wife as a means to lay out our financial independence journey and connect with and help others who share the same goal.
I have not been compensated by any of the companies listed in this post at the time of this writing. Any recommendations made by me are my own. Should you choose to act on them, please see the disclaimer on my About Young and the Invested page.