3 Tips to Help You Decide Whether Alternative Investments Make Sense for You
Alternative investing has become an increasingly popular option to diversify one’s investment portfolio among high-net-worth investors. And while alternative investments have the potential to generate higher returns than investments in traditional stocks and bonds, they also come with greater risks.
Following are three tips to help you decide whether adding an allocation to alternative investments makes sense for you.
#1 – Understand what you’re getting into.
The term “alternative” investment typically refers to any type of investment that’s not a stock, bond or cash equivalent. When you remove straightforward stock, bond and cash investments, you’re left with a diverse set of alternatives, including the following:
- Private investments – At Creative Planning, our definition of private investments refers to private equity, private credit, private real estate, private infrastructure and private hybrid funds. Private equity firms typically buy companies and overhaul them, then later sell them for a profit.
- Hedge funds – A hedge fund refers to a pool of private investor assets that’s managed by professional fund managers. These managers typically use a wide range of complex trading strategies in an effort to achieve above-average investment returns by buying and selling nontraditional assets. Hedge funds are typically risky strategies that are only available to high-net-worth investors.
- Real estate – Real estate investments may include investing directly in a physical property or purchasing shares in a fund that invests in real estate, such as a real estate mutual fund or a real estate investment trust (REIT).
- Art and collectibles – These include high-value objects, such as sports memorabilia, wine, jewelry, gold, artwork, coins, etc.
- Cryptocurrencies – This refers to digital currencies, such as Bitcoin.
#2 – Research the pros and cons of alternative investments.
Just like any investment, there are pros and cons to investing in alternatives.
Pros:
- Low correlation to overall market trends – One of the main reasons investors incorporate an allocation to alternatives is that the value of these investments tends to fluctuate independently of overall market trends. This reduced correlation can help buffer your portfolio against market volatility because it offers an opportunity to access returns that perform separately from traditional investments, such as stocks and bonds.
- Diversification – The potential for enhanced portfolio diversification is another main benefit of investing in alternatives. Alternatives are available in a wide range of markets, strategies, managers and investment types that differ from traditional investments.
- Enhanced return potential – Alternative investments have the potential to generate higher returns than traditional asset classes. For example, private equity investments offer an opportunity to participate in the growth of early-stage companies, providing the potential to generate significant returns over time as those companies grow.
Cons:
- Illiquidity – Many alternative investments are privately managed, which means they’re not held to the same pricing and reporting standards as publicly traded investments. Some alternatives invest in real assets, such as real estate, art and collectables, which makes it difficult to take your money out once you’ve invested. In fact, some alternatives remain illiquid for 12 years or more, and you may not be able to access your funds during that period. Before investing in alternatives, it’s important to understand the specific terms of the investment and ensure you’re comfortable with locking up your money for a significant amount of time.
- High fees – Alternative investments typically charge high fees, including management fees, ongoing service fees, incentive-based compensation for the asset manager, redemption fees and more. It’s important to carefully review any offering documents for all fees and expenses prior to investing.
- Complexity – Many alternative investments have complex investment structures that can be difficult to understand. These complexities can also lead to significant tax implications if not properly planned for. It’s also important to note that alternative investments aren’t typically regulated in the same manner as traditional investments, nor are they held to the same reporting requirements as public investments. These differences can lead to challenges with both transparency and pricing.
- High risk – Certain alternative investments are highly speculative and volatile. While these characteristics have the potential to result in high returns, they can also lead to significant losses. Your wealth manager can help you determine whether the potential benefits of a particular investment offset the additional risk.
- High investment minimums – In recent years, alternative investments have become more accessible to a wider range of investors; however, many alternatives still carry high investment minimums that make them better suited to high-net-worth individuals.
#3 – Work with your wealth manager to incorporate alternatives that make sense for you.
While an allocation to alternatives can make sense under specific circumstances, these investments aren’t right for everyone. Because they’re illiquid, complex and expensive, it’s important to thoroughly understand the potential impact of alternatives prior to making an investment. Work with your wealth manager to determine whether an investment in alternatives makes sense given your specific needs, current financial situation and future goals.
Could you use some help determining whether an allocation to alternative investments is a smart move for you? Creative Planning is here for you. Our experienced professionals serve as fiduciaries to clients, providing advice in your best interests. We understand it can be difficult to identify the right mix of investments for your particular situation, which is why we’ll work with you to establish a strategy to support you exactly where you are in your investing journey while helping you work toward your goals.
