12 Pros And Cons Of Alternative Investments — All About That Money

9 min readApr 21, 2023

Alternative investments have been gaining popularity among investors in recent years. While traditional investments such as stocks and bonds are still popular, alternative investments can offer diversification and potentially higher returns. In this article, we will provide a comprehensive guide to alternative investments, their pros and cons, and explore the different types of alternative investments available.

What Are Alternative Investments?

Alternative investments are any investments that do not fall into the traditional categories of stocks, bonds, and cash. These investments can include real estate, private equity, hedge funds, commodities, cryptocurrency, art, and collectibles, among others.

Unlike traditional investments, alternative investments are typically less regulated and can be more complex. They are often available only to accredited investors or high-net-worth individuals due to their higher risk and potential for greater returns. However, there are still many options for ordinary investors to take part.

Why Alternative Investments?

Investors may consider alternative investments for several reasons. One reason is diversification. Alternative investments can provide diversification by offering exposure to different asset classes and strategies.

Another reason is potential returns. Alternative investments can offer potentially higher returns than traditional investments. However, it’s important to note that higher returns often come with higher risk.

Finally, investors may consider alternative investments for their unique features. For example, real estate investments can offer passive income through rental income, while art and collectibles can appreciate in value over time.

Examples Of Alternative Investments

There are several types of alternative investments, each with its own unique characteristics and risk profiles, some popular assets include the following;

Real estate: Real estate investments can include direct ownership of a property, real estate investment trusts ( REITs), and crowdfunding platforms. Real estate investments can offer potential passive income through rental income and appreciation over time.

Private equity: Private equity investments involve investing in private companies that are not publicly traded. These investments often require a significant amount of capital and can be illiquid.

Hedge funds: Hedge funds are private investment funds that use a variety of investment strategies to generate returns. They are typically available only to accredited investors or high-net-worth individuals.

Commodities: Commodities are physical assets such as gold, oil, and agricultural products. They can be traded through futures contracts or purchased directly.

Cryptocurrency: Cryptocurrency investments involve buying and holding digital assets such as Bitcoin and Ethereum. Cryptocurrencies are highly volatile and can be difficult to value.

Peer-to-peer lending: Peer-to-peer lending involves lending money to individuals or businesses through online platforms. These investments can offer higher returns than traditional fixed-income investments but come with higher risk.

Venture capital: Venture capital investments involve investing in startup companies in exchange for equity. These investments can be high-risk but offer the potential for significant returns.

Watches and Jewelry: Watches and jewelry can be a unique form of alternative investment. Collectors may invest in high-end watches or jewelry pieces that may appreciate in value over time, especially if they are rare, vintage, or have a significant historical or cultural significance. However, it’s important to note that the value of watches and jewelry can be subjective and may not always follow traditional market trends.

Luxury Fashion & Accessories: Luxury fashion items, such as handbags, shoes, and clothing, can also be an alternative asset. Collectors may invest in rare or limited edition luxury fashion pieces that may appreciate in value over time, especially if they are from a well-known designer or brand. However, as with watches and jewelry, the value of luxury fashion can be subjective and may not always follow traditional market trends.

Coins: Coins, particularly rare or historical coins, can be a valuable alternative investment. Investors may collect coins as a hobby, but they can also appreciate in value over time. The value of coins can be influenced by factors such as rarity, historical significance, condition and precious metal content.

Trading Cards: Trading cards, particularly sports cards, can also be an alternative asset. Collectors may invest in rare or vintage sports cards that may appreciate in value over time, especially if they are in good condition and have a significant historical or cultural significance. The value of trading cards can be influenced by factors such as rarity, condition, and the popularity of the sport or athlete.

Whisky: Whisky can be a unique form of alternative investment. Investors may purchase rare or vintage bottles or casks of whisky that may appreciate in value over time, especially if they are from a well-known distillery or have a significant historical or cultural significance. The value of whisky can be influenced by factors such as age, rarity, and brand. However, as with other alternative assets, the value of whisky can be subjective and may not always follow traditional market trends.

Fine Art: Artwork can be a highly valuable alternative asset. Collectors can invest in paintings, sculptures, and other art pieces that may appreciate in value over time.

Wine: Similar to whisky, wine can also be a valuable alternative asset. Collectors may invest in rare and high-quality wines, which may appreciate in value over time.

Rare Books: Collectible books, such as first editions or signed copies, can be a valuable alternative asset. The value of these books can appreciate over time, especially if they are in good condition and rare.

Intellectual Property: Patents, trademarks, and copyrights can also be alternative assets. Investors can purchase the rights to these assets and receive royalties or licensing fees, which can generate income.

Risks Associated With Alternative Investments

Alternative investments are typically less regulated than traditional investments, which can make them more susceptible to fraud and other risks. They can also be illiquid, meaning it can be difficult to sell them quickly if needed.

Additionally, alternative investments can be complex and difficult to understand, which can make them unsuitable for some investors. Investors should carefully consider the risks associated with any investment before making a decision.

Pros And Cons Of Alternative Investments

Alternative investments can provide diversification and potentially higher returns, but they also come with risks and limitations. Here are six pros and cons to consider when investing in alternative assets:

Pros

Diversification: Alternative investments can provide diversification from traditional investments such as stocks and bonds, helping to spread out risk across a variety of assets.
Potential for higher returns: Alternative investments can offer higher potential returns than traditional investments, as they often involve less efficient markets and less competition for investment opportunities.
Access to unique assets: Alternative investments can provide access to unique assets such as private equity, hedge funds, and real estate, which may not be available through traditional investment vehicles.
Inflation protection: Some alternative investments, such as commodities and real estate, may offer protection against inflation by providing a tangible asset that can increase in value as prices rise.
Portfolio customization: Alternative investments can allow investors to customize their portfolios based on their risk tolerance, investment goals, and preferences.
Potential tax benefits: Certain alternative investments, such as real estate and energy investments, may offer tax benefits such as deductions and credits that can help lower an investor’s tax bill.

Cons

Illiquidity: Many alternative investments are illiquid, meaning they cannot be easily sold or converted to cash. This can limit an investor’s ability to access their funds in a timely manner.
Lack of transparency: Some alternative investments, such as private equity and hedge funds, may lack transparency and provide limited information to investors about their holdings and strategies.
High fees: Alternative investments often come with higher fees than traditional investments, which can eat into potential returns.
Limited regulation: Many alternative investments are not subject to the same regulations as traditional investments, which can increase the risk of fraud and abuse.
Higher risk: Alternative investments often come with higher risk than traditional investments, as they may involve less established companies, emerging markets, or speculative ventures.
Complexity: Some alternative investments can be complex and difficult to understand, requiring specialized knowledge and expertise to evaluate and manage effectively.

As with any investment, it is important to carefully consider the pros and cons of alternative investments and to consult with a financial advisor before making any investment decisions.

Alternative vs. Traditional Investments

Alternative investments differ from traditional investments in several ways. Traditional investments such as stocks and bonds are typically more regulated, more liquid, and easier to understand.

Alternative investments, on the other hand, are often less regulated, less liquid, and more complex. They can offer potential higher returns but also come with higher risk.

It is usually beneficial to hold a mix of both alternative and traditional assets to balance out an investment portfolio.

Tax Considerations For Alternative Investments

Alternative investments can have unique tax implications that investors should be aware of. For example, some alternative investments may offer tax benefits such as depreciation deductions or tax-deferred gains.

Investors should consult with a tax professional before investing in any alternative investment to fully understand the tax implications.

Accredited Investors

Some alternative investments may require investors to be accredited, which means they meet certain income and net worth requirements set by the Securities and Exchange Commission (SEC). This is because alternative investments can come with higher risk and are typically not as heavily regulated as traditional investments.

The SEC defines an accredited investor as an individual who has either:

A net worth of at least $1 million, excluding the value of their primary residence; OR
An annual income of at least $200,000 (or $300,000 for joint income with a spouse) for the past two years and a reasonable expectation of reaching the same income level in the current year.

Accredited investors are typically considered to be more sophisticated and able to handle the risks associated with alternative investments. Some alternative investment opportunities, such as private equity or hedge funds, may only be available to accredited investors.

On the other hand, non-accredited investors do not meet these income and net worth requirements and may have limited access to certain alternative investment opportunities. They may be more limited to publicly available investment options, such as stocks and bonds.

It’s important to note that being accredited does not necessarily mean an investor is guaranteed to make money, and non-accredited investors may still be able to find profitable investment opportunities. It’s important to conduct thorough research and due diligence before making any investment decisions, regardless of investor status.

How To Invest In Alternative Assets And Alternative Investment Platforms

Investing in alternative investments typically requires a larger capital outlay than traditional investments. Many alternative assets are only available to accredited investors or high-net-worth individuals.

Investors can invest in alternative investments through various channels, including private equity firms, hedge funds, crowdfunding platforms, and online marketplaces. It’s important to do thorough research and due diligence before investing in any type of investment.

Investing in alternative assets can be more complex than traditional investments, and there are several factors to consider before making any investment decisions. Here are some steps to follow when investing in these types of assets:

Determine your investment goals and risk tolerance: Before investing in any alternative asset, it’s important to understand your investment goals and risk tolerance. Alternative investments can come with higher risk, so it’s important to determine how much risk you’re comfortable taking on.
Conduct thorough research and due diligence: It’s important to research the investment thoroughly and understand the potential risks and rewards. You should also investigate the investment sponsor’s track record and experience in managing the specific asset class.
Evaluate the investment’s liquidity: Alternative investments can be illiquid, meaning that it can be difficult to sell the investment and access your funds. Before investing, it’s important to understand the investment’s liquidity and how long you may need to hold the investment.
Consult with a financial advisor or professional: Alternative investments can be complex, and it’s important to seek advice from a financial advisor or professional who has experience with these types of investments.

Alternative investment platforms can make it easier for individual investors to access alternative investments. Here are some steps to follow when investing in alternative investment platforms:

Research different platforms: There are several alternative investment platforms available, each with its own investment offerings, fees, and requirements. Research and compare different platforms to find the one that best fits your investment goals and risk tolerance.
Evaluate the platform’s due diligence process: Alternative investment platforms typically conduct due diligence on the investments they offer to investors. It’s important to understand the platform’s due diligence process and how they select investments.
Understand the fees: Alternative investment platforms can charge various fees, including management fees, performance fees, and transaction fees. It’s important to understand these fees and how they may impact your investment returns.
Consider the platform’s liquidity options: Alternative investment platforms may offer different liquidity options, such as secondary markets or redemption programs. It’s important to understand these options and how they may impact your ability to access your funds.

Investing in alternative assets and alternative investment platforms can be a complex process. It’s important to do thorough research and due diligence before making any investment decisions, and to consult with a financial advisor or professional to determine if these types of investments are suitable for your individual needs and goals.

Conclusion: Are Alternative Assets Right For You?

Alternative investments can offer investors the opportunity to diversify their portfolios and potentially earn higher returns. However, they also come with higher risk, complexity, and potential liquidity issues. Before investing in any alternative assets, investors should carefully consider the risks and do thorough research and due diligence.

Originally published at https://allaboutthatmoney.com on April 21, 2023.