A core tenet of portfolio construction is the need to diversify. Sure, investors love to see when all their holdings go up at the same time, but that can also mean the same investments all head south simultaneously.
To smooth returns and avoid the risk of a sharp pullback in your entire portfolio, consider alternative investments that have low correlations with stocks and bonds. That means assets that don’t move in the same direction as traditional investments, or at the same rate.
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What are alternative investments?
Alternative investments offer portfolio diversification beyond traditional stocks and bonds. The category includes assets such as real estate, commodities, hedge funds, private equity and venture capital, to name just a few.
In addition, assets such as art, coins and fine wine are considered alternatives, as they can also help diversify an investor’s net worth.
Why consider alternative investments?
The biggest reason to invest in alternative assets is to smooth a portfolio’s overall return using assets with low or no correlation to one another.
“It’s useful to have uncorrelated investments such as hedge funds, gold or commodities in a portfolio because their return patterns do not move in tandem with stocks and bonds,” said Drayton D’Silva, CEO and chief investment officer at Tower Hills Capital in New York City.
If the stock market is trending lower, uncorrelated assets may remain stable or even appreciate, reducing portfolio volatility and risk, he added.
“This is particularly important during market downturns or economic instability, where traditional assets might all simultaneously lose value and selling portfolio assets to fund other expenses at this point would crystallize a large loss,” D’Silva said.
Different types of alternative investments
Alternative investments come in many forms. For example, an investor could buy a highly liquid and publicly traded security such as a real estate investment trust (REIT) or, if financially viable, an office building.
Precious metals, agricultural futures and collectibles are other forms of alternative investments.
However, the best alternative investments differ depending on each individual’s situation, including goals, time horizon and risk tolerance.
1. Collectibles
People collect all kinds of unusual items. Often that’s just because they enjoy it, but sometimes collectors are looking for something with the potential to grow in value. In 2024, popular collectibles include antique furniture, vinyl records, toys, dolls, coins and stamps.
Sometimes those items end up collecting dust, but occasionally a collector can hit pay dirt:
Wine
The value of wine depends on numerous factors, including the year the grapes were harvested, the yield of the harvest in that year and weather patterns. These are excellent examples of factors uncorrelated to global equity markets, meaning that an investment in wine could be a way of balancing a more typical portfolio of securities.
In addition, collecting wine can be a fun and interesting hobby, which attracts many investors.
Fine art
Collecting art also attracts many investors because of the “fun” factor of learning about artists, subject matter and culturally significant pieces. According to a 2023 report from Bank of America’s private banking unit, in the next decade, the art market will be propelled by asset transfers from the Silent Generation and baby boomers to their heirs.
“The ‘great wealth transfer’ phenomenon will drive high-quality supply to the art market, either directly in the form of single-owner estate sales or by the sale of inherited works,” said Bank of America.
Collectible cars
Collectible cars, including classic cars, are a good example of an item whose supply is limited or dwindling, which means value may increase over time.
Eden Cooper, founder and managing partner of Drift Capital, a New York City-based asset management firm that invests in rare and valuable cars, said when comparing risk-adjusted returns, collectible cars have outperformed other collectibles.
“Investment-grade collectible cars have delivered robust returns over the past few decades while experiencing minimal losses,” he said. “Automobiles with celebrated histories can serve as cultural icons for generations to come.”
Blue-chip collectible cars, Cooper added, are considered Veblen goods — assets that tend to become more desirable as their prices increase.
“Given their tangible nature, collectibles can provide a hedge against inflation, serving as a store of value when fiat currencies lose purchasing power,” Cooper said.
However, not all asset managers are convinced that wine or other types of high-end collectibles are good investments.
“Investments in collectibles such as wine, fine art or classic cars are more to earn social capital and prestige rather than strictly for financial returns,” D’Silva said.
2. Real estate
Real estate is a popular alternative investment because of its potential for steady income, appreciation in value, tax benefits and portfolio diversification. Alternative real estate investments are tangible assets that often hold value better than stocks during periods of market volatility.
It’s also versatile, as real estate can come in several forms, such as buildings, raw land or through publicly traded REITs.
Commercial and residential properties
Commercial or residential properties can be reliable alternative investments for people looking outside of traditional stocks and bonds.
The macroeconomic environment for brick-and-mortar properties appears to be improving, said Paul Feinstein, CEO and chief investment officer at Audent Global Asset Management in West Hollywood, California.
“I believe we’re entering into a pretty good market cycle in the multifamily housing space. The banks are starting to loosen up and look for opportunities now,” he said.
If banks are more willing to lend to developers, that creates opportunity for real estate investors, he added.
Within the vast landscape of real estate investing, Feinstein sees a particular opportunity in student housing.
“With an increasing number of students residing on campuses and expanding educational needs, student housing presents an enticing prospect for investors, especially considering the number of college students in the US is projected to reach 19.25 million in 2024, with an average 95% occupancy rate,” he said.
Farmland
As technologies continuously improve agricultural efficiencies and yields, investors are finding more opportunities for investing in farmland.
In an April 2024 research report from Capital Group,” equity investment analyst Gigi Pardasani wrote, “One trend I’m following is precision agriculture — which is essentially the use of high-tech tools to grow crops more efficiently.”
She noted that those who employ “cutting-edge technology using machine learning, geolocation and sensors are able to make smarter decisions in the field.”
She added that farmers “who have already embraced precision agriculture have seen up to 30% greater productivity through a reduction in the number of passes on the field and improved soil.”
As with any other investment opportunity, greater efficiencies in farming can improve the bottom line, which can benefit investors looking to this asset class as an alternative to diversify their portfolios.
REITs
Real estate investment trusts are among the easiest ways for investors to get exposure to the real estate sector.
Because REITs are traded on exchanges like stocks, they’re accessible to investors who don’t have the capital to invest in physical real estate or just aren’t interested in owning properties beyond their primary residence.
By law, REITs are required to distribute at least 90% of their taxable income to shareholders in the form of dividends. This requirement makes REITs attractive to income investors, as well as those looking for alternatives.
3. Lending
Investors looking to diversify away from traditional stocks and bonds might also consider becoming lenders.
Crowdfunding
Crowdfunding offers a way for would-be alternative investors to diversify with a relatively little amount of money.
Crowdfunding uses online platforms to pool small contributions from numerous lenders to fund projects or ventures.
Popular crowdfunding platforms include Kickstarter, Indiegogo and GoFundMe, but there are many others.
Peer-to-peer lending
Peer-to-peer (P2P) lending uses online platforms to directly connect borrowers with investors, bypassing traditional banks. Their algorithms rely less on traditional metrics such as credit scores, which helps more borrowers access capital.
Of course, that means lenders are potentially taking on extra risk. That can boost their return, as can the entire process, which eliminates bank fees.
Popular peer-to-peer platforms include Kiva, Prosper and Upstart.
4. Commodities
Commodities can help investors hedge against inflation and diversify a stock-and-bond portfolio, as they often show low correlation to the broader financial markets.
Popular commodity investments comprise a broad range of assets, including precious metals, oil, natural gas, wheat, corn, copper and aluminum.
Gold & precious metals
Gold and other precious metals like silver are popular alternative investments for several reasons. Historically, they tend to store their value. They may also offer a hedge against inflation and potentially provide a safe haven during equity market volatility.
In 2024, gold and silver performed well, even as stocks also rose. Inflation, high interest rates and geopolitical uncertainty were among factors that sent investors scurrying into precious metals.
Agricultural commodities
Agricultural commodities such as grains, oil seeds and livestock are traded using futures. Each agricultural market has its own distinctions, so investors should understand the market carefully if they’re thinking of getting into commodities as alternative investments.
Frequently traded agricultural commodities include corn, cattle, soybeans, dairy products, hogs, hen eggs, wheat and hay.
5. Venture capital
Venture capital is a way of investing in businesses outside of stocks on major exchanges. Many of the biggest publicly traded companies began life with funding from venture capitalists before going public.
Venture capitalists get their payout when their portfolio companies go public or are acquired.
“Venture capital provides investors with the ability to participate in the acceleration, growth and impact of tech-enabled innovation, driving some of the most significant market leading companies in history,” said Daryn Dodson, founder and managing partner at Illumen Capital, a venture capital firm in Washington, DC.
“Investing in venture capital means supporting innovation and technology while also aligning with the values that matter to society,” Dodson said. “It also allows investors to actively influence who creates the next leading technology and for whom these products are developed.”
6. Digital assets
Digital assets have taken center stage in recent years as cryptocurrencies rallied to new highs. However, products such as online courses, software and apps can also be considered digital assets; developers of these platforms are de facto diversifying their portfolios with these products that have the potential to generate revenue and be sold.
Cryptocurrencies
With the US Securities & Exchange Commission (SEC) approving exchange-traded funds (ETFs) that invest in cryptocurrencies directly or via the futures market, cryptocurrencies are more accessible than ever to a wide range of investors.
Cryptocurrencies are viable alternative investments due to their potential for high returns, technological innovation and as a hedge against traditional banking systems and equity markets.
NFTs
Non-fungible tokens, or NFTs, allow creators to monetize their digital content and offer collectors verifiable ownership of unique items. Some investors consider NFTs as alternative investments because they offer opportunities for diversification, along with scarcity and potential for high returns.
For investors who are skeptical about NFTs’ potential, consider this: The priciest NFT — The Merge, created by digital artist Pak — sold for nearly $92 million in December 2021.
7. Royalties
Not all investors consider royalties as alternative investments, but there’s ample opportunity here for income.
Royalties offer consistent revenue streams from intellectual property such as music, books or patents on intellectual property. Investors receive payments based on the use or sales of these assets. Royalties provide diversification as they are insulated from stock market volatility, making them attractive choices for income-seeking investors who want a stable cash flow.
Investors interested in exploring royalties as an alternative can research platforms such as Royalty Exchange.
8. Private equity
Private equity is the process of investing in private companies or taking public companies private, with the aim of restructuring, improving operations and eventually selling for profit.
A prominent example of private equity is Dell Technologies, which was taken private by a private equity firm in 2013. The company restructured and focused on new markets. Private equity investors got their return when Dell went public again in 2018.
Growing industries are often a focus of private equity firms.
“Private equity, or PE, is particularly appealing for those who want to contribute to the energy transition,” said Dodson.
This holds true, he said, across industries ranging from product packaging to developing energy-efficient vehicles.
Dodson also cited the role that private equity can play in job creation, as well as in addressing biases that lead to low numbers of women and people of color in asset management.
“The positive effects of implementing strategy to address racial and gender bias in selecting companies and hiring processes in PE firms tend to be felt more directly by employees, especially in smaller-sized firms, where new structures reach employees directly,” he said.
9. Litigation finance
Litigation finance is another form of alternative investing that traditional investors may not consider or even know about. It involves funding legal cases in exchange for a cut of the settlement or judgment. Litigation financing allows investors to diversify their portfolios, potentially earning hefty returns if cases succeed.
However, investors are taking on the risk of an uncertain litigation and a drawn-out legal process.
“Litigation finance offers equity-like returns uncorrelated to the broader market,” said Eva Shang, CEO of Legalist, an alternative asset management firm in San Francisco, California.
“While there are many asset classes that claim to be uncorrelated, litigation finance is one of the few types of investments where the outcomes truly hinge on the merits of the litigation itself — a dispute between two parties,” Shang said. “Historically, litigation finance funds have posted returns comparable to private equity, but in an ‘off the beaten path’ asset class.”
How to invest in alternative assets
As you’ve seen, the investment landscape is vast for alternative assets. The best way to learn about investing in alternatives is to select the asset categories that interest you the most and start doing some homework.
Start by understanding which categories catch your eye. Maybe you like the idea of collectibles but have no interest in real estate. Within the category of collectibles, maybe cars seem too pricey, but you believe you can get started with baseball cards. From there, continue doing your research to learn more about that particular market.
Likewise, if you’re drawn to real estate, decide whether you want to be a landlord, flip houses or buy an exchange-traded REIT and add that to your investment portfolio at your brokerage.
When doing your research on alternative investments, don’t overlook factors such as your risk tolerance, the investment’s liquidity and its potential return. On the latter, be realistic: Avoid anchoring to outlying high returns.
Pros and cons
Every investment has pros and cons. It’s the potential downside of any investment that leads to risk, which is what investors are ultimately rewarded for.
“Alternative investments do have some downsides,” said Faron Daugs, wealth advisor and CEO at Harrison Wallace Financial Group in Libertyville, Illinois.
“Often, you need to be an accredited investor with a certain level of income and net worth,” he said. “Additionally, liquidity may be limited for a certain period or at specific intervals, meaning you may not be able to easily withdraw your investment as you could in the stock market.”
While alternative investments offer additional diversification and can be beneficial in client portfolios, he added, it’s crucial that investors understand exactly what they own, how they will receive returns on their investments and how they can retrieve their initial investment if needed at any time. In other words, you can easily sell a stock if you need cash quickly, but it’s not so easy to cash out your private equity alternative investments or sell that office building.
Frequently asked questions (FAQs)
While everyone’s investing aims differ, newbies to alternative investing should narrow down what interests them and match investments to their risk tolerance and investment goals. In addition, consider the investment’s liquidity and how you’ll eventually get your return.
It’s impossible to determine the best alternative to stocks because it depends on factors such as a given investor’s goals, time horizon and risk tolerance. The best alternative investment is one that meets an investor’s criteria as well as one that the investor understands and is willing to hold through the inevitable ebbs and flows common to any type of asset.
The risk levels of alternative investments vary. Depending on the reason for seeking an alternative investment, investors may want to take more risk or less risk.
Alternative investments can potentially offer tax-saving benefits. For example, certain types of real estate, like rental properties, may offer investors tax deductions. Additionally, some alternative investments may offer tax-advantaged structures or strategies that reduce overall tax liabilities. For example, REITs distribute the majority of their taxable income to shareholders, resulting in tax-efficient dividends.