Alternative investments encompass everything outside traditional stocks, bonds, and cash. These assets can provide diversification benefits, inflation protection, and potentially higher returns. However, they also come with unique risks and considerations that every investor should understand.
What Are Alternative Investments?
Alternatives include asset classes that behave differently from traditional investments:
- Real estate and REITs
- Commodities (gold, silver, oil)
- Private equity and venture capital
- Hedge funds
- Cryptocurrencies
- Collectibles and art
- Infrastructure investments
Key benefit: Alternatives often have low correlation with stocks and bonds, meaning they may hold value or even rise when traditional markets decline. This makes them valuable for diversification.
Real Estate
Direct Real Estate Ownership
- Rental properties: Income from tenants plus appreciation
- Commercial real estate: Office, retail, industrial properties
- Pros: Tangible asset, income, tax benefits, inflation hedge
- Cons: Requires capital, management, illiquid, local market risk
REITs (Real Estate Investment Trusts)
- What they are: Companies that own income-producing real estate
- Types: Residential, commercial, healthcare, data centers, towers
- Pros: Liquid, diversified, professional management, dividend income
- Cons: Correlated with stocks, interest rate sensitive
- Allocation: 5-15% of portfolio is common
Real Estate Crowdfunding
- Pool money with other investors for specific properties
- Lower minimum investments than direct ownership
- Less liquid than REITs
- Platforms offer various risk/return profiles
Commodities
Gold
- Role: Store of value, crisis hedge, inflation protection
- Access: Physical gold, gold ETFs, mining stocks
- Pros: Uncorrelated with stocks, holds value during crises
- Cons: No income, storage costs for physical, volatile
- Allocation: 5-10% is common for those who want gold exposure
Broad Commodities
- Categories: Energy, metals, agriculture, livestock
- Access: Commodity ETFs and mutual funds
- Pros: Inflation hedge, diversification
- Cons: Do not produce income, storage and rolling costs
Precious Metals
- Options: Gold, silver, platinum, palladium
- Silver: More volatile than gold, industrial uses
- Platinum/Palladium: Industrial metals with different dynamics
Cryptocurrencies
Overview
- What they are: Digital assets on blockchain technology
- Major coins: Bitcoin, Ethereum, and thousands of others
- Characteristics: Highly volatile, 24/7 trading, decentralized
Investment Considerations
- Pros: High return potential, uncorrelated (historically), innovative technology
- Cons: Extreme volatility, regulatory uncertainty, security risks
- Allocation: Only what you can afford to lose completely, typically 1-5%
Access Methods
- Direct purchase on crypto exchanges
- Bitcoin and crypto ETFs
- Crypto-related stocks (exchanges, miners)
Private Equity and Venture Capital
What They Are
- Private equity: Investing in established private companies
- Venture capital: Early-stage startup investing
- Access: Traditionally limited to accredited investors
Considerations
- Pros: High return potential, access to private markets
- Cons: Illiquid (7-10 year lockups), high minimums, risky
- Access for individuals: Some platforms now offer lower minimums
Other Alternatives
Infrastructure
- Roads, bridges, utilities, airports
- Stable cash flows, inflation protection
- Access through infrastructure funds or MLPs
Hedge Funds
- Various strategies: long/short, arbitrage, macro
- High fees (typically 2% + 20% of gains)
- Some liquid alternatives available as mutual funds
Collectibles
- Art, wine, cars, sports memorabilia
- Passion investments with potential appreciation
- Illiquid, requires expertise, storage costs
- Generally not recommended as investment strategy
Building an Alternatives Allocation
How Much in Alternatives?
- Conservative: 5-10% of portfolio
- Moderate: 10-20% of portfolio
- Aggressive: 20-30% of portfolio
Sample Alternatives Allocation
- REITs: 5-10%
- Commodities/Gold: 5%
- Crypto (if any): 1-5%
- Other alternatives: As appropriate
Implementation Tips
- Start small and increase as you learn
- Use liquid vehicles (ETFs) when possible
- Understand the risks before investing
- Do not chase performance
- Consider tax implications
Risks of Alternative Investments
- Liquidity risk: May be hard to sell quickly
- Complexity: Harder to understand and evaluate
- Higher fees: Active management often costly
- Valuation challenges: No daily market prices for some
- Regulatory risk: Rules may change, especially for crypto
- Fraud risk: Less regulated markets attract bad actors
Track All Your Investments
Pro Trader Dashboard helps you monitor your alternative investments alongside traditional holdings.
Summary
Alternative investments can enhance portfolio diversification and provide protection against inflation and market downturns. REITs and commodities are the most accessible alternatives for individual investors. Cryptocurrencies offer high potential but come with extreme risk. Keep alternative allocations modest (5-20% of portfolio) and understand the specific risks of each asset class. Use liquid vehicles like ETFs when possible, and only invest in alternatives you truly understand.
Learn more: asset allocation guide and bond allocation strategies.