When many people think of investments, they likely think about stocks, bonds, Treasury issues, and cash instruments such as bank savings accounts and certificates of deposit (CDs). But there’s a wide range of different kinds of securities outside of these traditional types of investments that Frontier believes you should understand.
These non-traditional investments are sometimes referred to as alternative investments. Simply put, an alternative investment is any investment that falls outside the realm of traditional stocks, bonds and cash equivalents.
Types of Alternative Investments
The term “alternative investments” may potentially conjure up images of exotic, high-risk instruments that are only available to the wealthiest individuals and large institutional investors. However, this is no longer the case, as the following investments are usually categorized as alternative investments:
- Hedge funds and private equity
- Managed futures contracts
- Real estate, real estate partnerships and real estate investment trusts (REITs)
- Derivatives contracts
- Cryptocurrencies like Bitcoin
- Master limited partnerships (MLPs)
- Art and collectibles
Other common types of alternative investments are precious metals — such as gold, silver, platinum and palladium — and commodities. These include natural gas, crude oil, ethanol, soybeans, coffee, sugar and beef cattle.
One of the main benefits of including alternative investments in your portfolio is that they can provide an added layer of diversification. Alternative investments usually have a low correlation with traditional investment securities. In other words, when traditional assets are moving in one direction, alternative assets may be moving in the other direction. So investing in alternatives can help smooth out portfolio volatility.
Frontier acknowledges that alternative investments like gold also represent safe havens during times of political and economic instability and serve as a hedge against inflation and a declining dollar. Alternatives can also offer tax benefits, such as tax-loss carryforwards and favorable long-term capital gains tax rates.
Should You Invest in Alternatives?
In the right circumstances, choosing alternative investments can be a smart move for your portfolio. If an individual’s net worth and investible assets grow, the alternative investments can help spread your assets out among a wider range of different types of securities, which in turn can reduce volatility and potentially increase returns. Although some people believe that alternatives as a group are riskier and more volatile than traditional investments, Frontier does not generally believe that is case.
Frontier has noted some potential drawbacks to alternative investments that you should be aware of. For starters, they tend to be more complex than traditional investments like stocks, bonds and cash equivalents. Access to some alternative investments can be limited to what are referred to as “accredited investors.” These are investors who have an annual income of at least $200,000 (or $300,000 for married couples) or a net worth of at least $1 million, and who also possess a higher level of investment knowledge than average investors.
Some alternative investments are also less-regulated than traditional investments, so there’s less investor protection from possible fraud. Based on our findings, many alternative investments also feature high minimums and high fee structures compared to traditional investments. And some alternative investments are highly illiquid, which can make it difficult or impossible to access your money if you need to in case of a financial emergency.
How to Invest in Alternatives
Investing in alternatives can be fairly simple or complex, depending on the specific type of alternative you want to invest in. For example, you can choose mutual funds and exchange traded funds (ETFs) that focus on alternative investments like real estate, commodities, precious metals and even cryptocurrencies.
However, you must be an accredited investor (as described above) to invest in hedge funds. And investing in more niche alternatives like art and collectibles, rare coins, fine wine and music royalties generally requires a high level of knowledge and expertise in these areas.
Worth a Closer Look?
Frontier believes that in our current environment in which stock valuations are relatively high and interest rates are on the rise, it might make sense to take a closer look at whether adding alternative investments to your portfolio makes sense.
Please contact us if you have more questions about alternative investments and their possible role in helping you meet your financial and investing goals.