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Some investors aren’t content to settle for traditional investments. Instead, they seek investment opportunities outside the norms of instruments like stocks and bonds. Alternative investments provide investors with a unique opportunity to diversify a portfolio even further. Plus, the returns are historically higher than traditional investments.
Alternative investments definition
So, what are alternative investments? An alternative investment is essentially any financial asset that doesn’t fall within the five standard investment categories: equity, bonds, cash, real estate, and futures and derivatives. You’ll find that the majority of alternative investments are not actually regulated by the SEC and thanks to advances in technology – such as online brokers – alternative investments are more accessible than ever to the retail investor.
There are two main kinds of alternative investments. The first is private assets like private real estate and private credit. With far more complexity than public stocks and bonds, these private assets are traded less frequently but can provide an additional source of income to the right investor.
The second kind of alternative investments that is available to investors is hedge funds – public market trading that involves less traditional methods, such as using leverage and short-selling instruments. Hedge funds are sometimes referred to as actively managed alternative investment funds and their purpose is to raise capital for several participating investors.
Alternative investments examples
A common question asked by investors to financial advisors is “is gold an alternative investment?” As a commodity, it certainly is. Here are the different types of alternative investments most commonly presented by financial advisors:
Private equity refers to an investment into non-publicly traded companies, while real estate is only considered an alternative asset investment when purchasing an investment property such as an office building. Some financial investors may even consider exchange-traded funds as an alternative investment.
Alternative investment strategies
Alternative investments don’t really correlate with traditional investments. Of course, that’s what makes them such a desirable way to achieve a diversified portfolio. Generally, alternative asset investments are the inverse of traditional asset classes. For example, a standard asset like currency is significantly hurt by investments into an alternative asset investment like gold. Not only is gold an alternative investment, but it’s a proven hedge against inflation, too.
However, because alternative investments work against traditional assets, plenty of institutional funds will only allocate a very small percentage – usually no more than 10% – to alternative investments.
The pros and cons of alternative investments
Alternative investments are no longer the exclusive tool of institutional and high-capital investors. Today, even retail investors can take advantage of an alternative asset investment, so it helps to know the pros and cons of alternative investments.
Alternative investments offer a great chance to diversify a portfolio due to the fact that these assets do not correlate with traditional instruments. You may also find some tax benefits that traditional investments cannot offer. Also, while no investment is a sure-fire guarantee, alternative investments tend to offer much higher returns.
There are, of course, unique risks when implementing alternative investment strategies. These assets are more complex and there are risks associated with not understanding the instrument or strategy fully. Alternative investments also have higher fees than traditional investments such as fund management fees.
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