An alternative investment is basically any investment that doesn’t fall into the traditional investment categories of public stocks and bonds. In the past, alternative investments have primarily been available to institutional investors, like pension funds, but they are now becoming more easily available to individual investors as well.
Characteristics of Alternative Investments
There are a wide range of alternative investments to choose from, but all of them tend to share a few important characteristics.
- Unlike stocks, many alternative investments are not regulated by the U.S. Securities and Exchange Commission (SEC).
- Often, alternative investments are illiquid, which means they can’t easily be sold or converted into cash.
- Because alternative investments are not part of a standard asset class, their performance does not necessarily move in the same direction as the stock market and other traditional assets. In other words, alternative investments do not always correlate to the stock market.
Using Alternative Investments to Diversify Your Portfolio
Alternative investments are a broad class of assets, ranging from hedge funds and real estate to commodities, like gold and other precious metals. Many investors use alternative investments to diversify their portfolios and mitigate risk, since alternative investments do not always correlate to the stock market. If traditional investments like stocks aren’t performing well, then alternative investments, which aren’t tied to the performance of the stock market, could potentially offset a loss.
Alternative Investment Options
There are many alternative investment options for individual investors, and there are pros and cons to each of them. Here are a few of the most popular alternative investments for individuals.
- Real estate is one of the most common alternative investments, and most investors typically have some portion of their assets invested in a primary residence or other real estate investments. Some people invest actively in real estate by purchasing and managing a rental property on their own, while others choose to passively invest in residential, industrial, or commercial real estate through a real estate crowdfunding platform or a Real Estate Investment Trust (REIT).
- Private equity is another kind of alternative investment, where capital is invested in private companies that are not listed on a public stock exchange. Venture capital is one well-known type of private equity investing. Most private equity investments are restricted to institutional investors and a handful of high-net-worth individuals who must meet very stringent income and asset requirements to participate. However, there have been discussions recently about expanding retail investors’ access to private markets through private equity funds and other regulated investment vehicles.
- Peer-to-peer lending is a way for investors to pool their money with others to fund loans for individuals and businesses. Borrowers apply for loans on the peer-to-peer (or P2P) lending platform, and they often find it faster and easier than getting a loan through a bank. Investors never deal directly with borrowers, and typically they invest in just a portion of each borrower’s loan, which allows them to distribute their investment across multiple loans and borrowers to reduce their risk.
- Commodities are an alternative investment category with a longer history than others. The value of commodities, like precious metals, agricultural products, and fossil fuels, rise and fall as supply and demand change, so they are not correlated with the stock market and often perform differently. Commodities are frequently used as a hedge against inflation. Precious metals, like gold, can also be more liquid than other types of alternative investments.
Real estate crowdfunding is an alternative investment, and it’s a relatively new and accessible way to passively invest in real estate. Typically, crowdfunding requires a lower minimum investment than other forms of passive real estate investing, which allows investors to participate in bigger deals and invest in different kinds of properties than they could afford on their own. With real estate crowdfunding, investors get the diversification benefits of owning a rental property, but without all the hassles of choosing, buying, and managing the property.
Choosing the right property to invest in is critical for a successful outcome, so you want to find a crowdfunding platform with experienced underwriters who can weigh the pros and cons of each property and choose the ones with the best chance of success. As a real estate crowdfunding investor, some platforms, like ArborCrowd, will allow you to see all the details about a property before you commit. They even offer virtual video tours of their properties, so you can see exactly what you’re buying into.
Once you buy into a crowdfunding deal, the deal manager or sponsor handles all of the property management and maintenance. As an investor, you won’t need to find tenants, coordinate repairs, or collect rent. The deal manager also handles all of the legal aspects of buying a property and managing tenants. This reduces the risk for investors, especially as rental laws continue to change over time. Compared to buying a rental property on your own, which is usually a very hands-on process, passively investing in a property through real estate crowdfunding is much simpler and easier.