Alternative Investing 101
Alternative investments are a great way to diversify your portfolio and often times have higher returns and little to no correlation with traditional equity markets
Disclaimer: This is not financial advice. I am not a financial advisor, just a practical guy, writing about a practical world.
Stocks, bonds and cash are the most widely known asset classes to the average investor. Stocks tend to be a bit volatile and, as we have seen over the last few years, can go up or down based on a tweet. Bonds are generally a safer asset class but the returns are often much lower and fluctuate based on federal rates. Cash is cash and earns little to no interest. Cash has been important this year, but ultimately, not a long-term strategy to increase net worth. For more information about investing in stocks, especially during a pandemic, check out a previous article I wrote.
Enter alternative investments. Alternative investments are any asset class, excluding the three I listed above. Alternatives investments (alts, going forward) include real estate, cryptocurrency, peer-to-peer lending, company debt and equity, wine, art and much more. The benefit of alts is they rarely correlate to the stock market as well as bigger events going on in the world. They tend to perform well; typically in the range of 9–20% APR and there are several options to choose from. The tradeoff is a fair amount of alternative investments are only open to accredited investors and alts typically have a higher risk associated with them. I would argue though that over the last few years the risk level associated with alts have decreased significantly and more are becoming available to all investors.
Alternative investments are a great way to diversify any portfolio. I’m in my mid-30s and I allocate 20% of my portfolio to alternative investments. Another 70% goes into stocks and 10% in bonds. I focus my alternative investments into real estate, cryptocurrency and company debt (notes). I target anywhere from a 9–13% return and I consistently see those returns, even during this pandemic. Below, I will provide more detail about some of my top alternative investments and the platforms to invest on.
The alternative investments summarized below include company debt, commercial real estate, cryptocurrencies, wine and peer-to-peer lending. Not all alts are created equal and I will highlight the pros and cons as you read through the sections.
Company Debt
Company debt, also known as debt financing, is when a company raises money by selling assets to investors and paying them back over time with interest. One of my favorite types of company debt is called payable notes. The simplest definition of a note is a promise to pay an investor back with interest. Interest is typically paid back in daily, monthly, or quarterly installments and starts either right away or after a designated period of time. At an agreed upon future date the principal will also be returned.
Cadence is a platform I highly recommend for investing in payable notes. Cadence is only a few years old but they have a very impressive track record. The track record consists of a 10% APR and a default rate of only 1.3% at the time of writing. Personally, my rate of return this year is at 11% and not a single one of my eight notes has defaulted. All of them have paid back in full and on time. Cadence allows accredited investors to crowdfund company debt. The funding companies, known as originators, range from power sports, to mobile devices, cryptocurrencies, and software applications. The originators typically lend to small to medium sized business across multiple geographies. The rates that Cadence provides are much more attractive than a typical bank and in some cases banks may not even lend to industries such as crypto. The notes themselves are short term, one of the biggest selling points. In my opinion, the shorter the duration, the less risk. For the technology enthusiasts, Cadence also leverages Blockchain technology to store transaction data on. For my additional thoughts on cryptocurrencies, check out a recent article I wrote. The notes I typically invest in range from one to three months, with an APR between 10% and 14%. To ensure enough diversification, I actually invest in every note that meets that criteria. The minimum amount to invest is $500 per note. Cadence also leverages a neat process known as a Dutch auction, which allows investors to set the APR for reach note. In addition, the accreditation process to invest is very simple and they execute it through a simple self-verify process. Lastly, Cadence does not charge investors any fees, which is a huge selling point. Fees are only charged to originators.
I want to briefly explain why I prefer lending to a company instead of lending to a person, as you will read more about in the next section. The answer is very simple; less risk. If you lend to a single person and that person loses their job they can decide immediately to stop paying and there is little that can be done. However, companies often have more cash available, are regulated by multiple agencies and they will have insurance and protection in place in case they or their customers lose money. The section below on peer-to-peer lending captures my specific experiences and why I have shied away from that industry.
Peer-to-Peer Lending
Peer-to-peer (p2p) lending is similar to payable notes. The difference is that with p2p lending, one person lends to another person. The recipient of the money is required to make recurring payments, with interest, to the lender. Typically, the recurring payments are made monthly. The type of people that typically apply for a p2p loans have lower credit scores, possibly poor relationships with banks and even a history of defaults. They also may not even have a job at the time. Peer-to-peer loans typically have a higher interest rate, due to the higher risk and a longer time horizon. Rates range from 10% all the way up to 35% and the duration is anywhere from three to five years. Investors are presented with high return potential; however, my results were far different. My p2p lending experience took place over the last three years, with one of the biggest players in the industry, Lending Club.
Lending Club uses the model I described above. They also rate the loans based on risk, so in theory you can be more conservative, or extra aggressive. I unfortunately found out that Lending Club’s risk assessment is not very accurate, in addition to its screening process, which has played a big part in the company’s struggles this year. I took the Lending Club approved approach and invested in 100 different loans with varying levels of risk, but I was also a bit more conservative. I learned very quickly that people that seek p2p loans can often not be trusted. Of the 100 different loans I started with, three of them defaulted within the first two months. By the end of all of the loan completion dates, eleven had defaulted, or 11% of my total portfolio. In addition, the majority of the defaulted loans were riskier and higher rates. That means my average rate of return was hurt even more. After three years, my rate of return, using the recommended approach, was a measly 5.5% APR. I had no intent of holding up my money for three years for rates that low. Part of the challenge with a company like Lending Club is its screening process is too automated and it lets in too many unqualified people. In addition, if an individual decides to stop paying their loan, even after the first payment, nothing really happens. Lending Club will try and reach out to the individual, but I almost never saw that work. Typical scenario is it will just negatively impact their credit score. Unfortunately, that does not help me as an investor. Fast forward into 2020 and Lending Club made a decision to stop all p2p lending and instead just focus on its banking practice. My understanding is they had a combination of problems. People stopped paying back loans, investors got frustrated and stopped using the platform. Lending Club would raise rates even more, which then turned potential recipients off more and the cycle continued long enough until the business no longer made sense. As of this end of this year, Lending Club will stop p2p lending. This is a reminder that not all alternative investments will return what they promise and not all alts are for every type of person. For me, lending to other people is just too risky. However, there are a few other platforms available, such as Peerform, Upstart, Prosper, Funding Circle and Payoff.
Real Estate Crowdfunding
Real Estate, in my opinion, is the most consistent and valuable alternative investment. It is also the most commonly known investment outside of traditional assets. Real estate is responsible for making many millionaires. Real estate rarely correlates to the stock market, but as we have seen over the last two decades, even the housing market can crash and a lot of value can be lost. Real estate investing comes in many forms. It can be buying, remodeling and selling. Or it can be buying and renting. Stay tuned for a future article on my specific real estate investing experiences with rental properties. It can also be done passively through different investment vehicles and funds. But, my favorite way to invest in real estate is through passive real estate crowdfunding.
Fundrise is my favorite option for passive real estate investing across commercial and residential properties. Fundrise makes the process effortless for investors and is a much more convenient option to owning properties than actively owning and managing, on your own. Fundrise lets investors buy into one of three funds that hold properties across the country. They use a crowdfunding model, so you are buying into the fund with several other investors and you don’t physically own any of the properties, which is great, less liability. The three different funds offered are funded through debt, equity, or a mix of both. Equity is expected to have higher returns in the long-term, while debt will have a more consistent income stream. Fundrise charges a 1% management fee, which can also be removed by referrals. The great part about the funds that are available is they hold a lot of properties. I am invested in the growth (equity) fund and I currently have 129 properties in it. Most of the properties are apartments but some are commercial buildings. Fundrise lets you set auto investing up and the platform also integrates with Mint and Personal Capital for portfolio tracking. Fundrise boasts higher than average returns and little to no stock market correlation. Over the last year, my portfolio is up 8% and that includes a lot of the early-on housing challenges that the pandemic created. In the long-term, I expect to see a 12–14% annual return. Returns are in the form of appreciation and dividends, and payments are made quarterly. Fundrise also provides tax forms, which is convenient and not always the norm with alts. Fundrise also has an option for accredited investors that allows the individual to select their own properties, but this option is higher risk and the average returns they report are not much better than the traditional funds they offer. If you are an accredited investor, I encourage you to look into CrowdStreet which boasts much higher returns and also has a solid track record. I personally recommend every investor have some real estate holdings in their portfolio. It is one of the best performing asset classes in history and it is a fantastic way to diversify your portfolio.
Cryptocurrencies
Cryptocurrencies are my favorite alternative asset. They are also the riskiest and for good reason. They are very volatile, easy manipulated and speculative. However, underlying blockchain technology has so much promise and I believe that only a handful of cryptocurrencies will reign supreme in the future. As I wrote about in a previous article, Bitcoin is the king of cryptos and the bellwether for the rest of the market. Bitcoin is currently trading over $22K, up over 200% just this year. Buying and selling crypto is still a challenging process and not something the average investor can figure out, especially when most platforms do not accept fiat (US dollars). Coinbase is one of the few platforms that has figured out how to bring crypto to the masses.
Coinbase is known as the top platform in the crypto space. It offers buying, selling and withdrawals of the biggest currencies and they allow purchases to be made in US dollars. They also make the process very easy, especially for the average investor. The fees that Coinbase charges are not cheap and they are known for recurring outages, but those challenges are overshadowed by the ease of use. Coinbase also offers transaction reports but does not offer tax forms. I have been invested in crypto since early 2017 and have continuously bought more, which has shown to be very profitable. I expect crypto to have a bright future and will continue to buy more over the next several years. Regulation in the crypto space is still a gap, but there is a lot of work being done as I write this. I would like to see Coinbase increase transaction limits, provide tax documentation and fix the frequent outages. Overall, it is still the best platform to buy crypto and if you are considering doing it, I encourage you to check out Coinbase before venturing to any other platforms.
Wine
Wine is a very interesting alternative investment and one I admittedly don’t know as much about, but it has been an up and comer over the last few years. Wine has very little correlation to the stock market and over the last 15 years it has performed substantially better, at 14%. Wine is consumed all times of the year and during a pandemic or economic depression consumption goes up even more. When it comes to investing in wine, it comes down to appreciation over time. One of the few platforms that is all about wine investing is called Vinovest.
Vinovest was created by an entrepreneur by the name of Anthony Zhang, who has a very impressive background. Here is a great read about Anthony and his successes. Vinovest is a platform that allows investors to purchase bottles of wine. The wine itself is picked through curated portfolios that are determined by level of risk, conservative, moderate and aggressive. The wine is finer and more elegant and is picked by master sommeliers. The type of wines that are picked are ones that will appreciate over time. To really benefit from appreciation, most wines take 10–30 years to realize full value. Vinovest does have a lot of success stories of wines that have doubled in value in just a few years. Vinovest does have a higher minimum investment at $1,000, but they also allow automatic investments. The fees are also high and range from 2.5% to 2.85%. The best feature about Vinovest is that when you invest in a specific wine or fund, you actually own the wine. That means, if you choose, you can have the wine sent to you to drink it. It truly is a liquid asset. It does also mean that it is more difficult to sell the wine once it has appreciated enough. Vinovest estimates four to six weeks for a transaction to complete. Wine, like art, is a relatively new alternative asset with a strong track record that is an excellent way to diversify a portfolio.
Conclusion
It is clear that alternative investments have a place in every investor’s portfolio. It is not to take any credit away from stocks and bonds, but as we have learned in the last couple decades, diversification is important. There are so many opportunities for investors to diversify and more of them are becoming available to the average investor, with minimal overhead necessary. Alternative investments, like all investments should be managed with a certain level of risk and skepticism and I always say, never invest more money than you are willing to lose. This is a statement that holds true for any asset. All alternative investments should be assessed individually and an adequate amount of research should be done. When I first looked into Cadence and Vinovest, I spoke with both of the CEOs to learn more about the market, their vision and the roadmap for the platform. Do your due diligence, pick some smart investments and you will be pleasantly surprised by the results in your portfolio.
Questions? Comments? Feedback? Reach out to me at trythepracticalworld@gmail.com or find me on Facebook, LinkedIn, Twitter and Instagram (@thepracticalworld)
The Practical World
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