Alternative Investments: Definition, Examples, Strategies
Table of Contents
While most investors are familiar with stocks, bonds, and cash, there is a world of investment opportunities beyond these assets.
Alternative investments are those outside of traditional assets. While they can be higher risk, alternatives can offer various potential upsides for investors, such as diversifying an existing investment portfolio, higher returns compared to stocks and bonds, and the opportunity to earn passive income.
Key Points
• Alternative investments include assets other than stocks, bonds, and cash, such as collectibles, commodities, derivatives, real estate, private equity, venture capital, hedge funds, and more.
• Alternative investments may provide portfolio diversification, as they often have a low correlation with traditional asset classes.
• Alternative investments have the potential to generate higher risk-adjusted returns compared with traditional assets, though this also comes with higher risk.
• Alternative investments tend to be illiquid, not as transparent as other financial assets, and may include the risk of total loss.
• You can invest in alternative investments through mutual funds, ETFs, interval funds, REITs, MLPs, or by working with an experienced asset manager.
What Are Alternative Investments?
Alternative investments — commonly known as alts — are those that are different from conventional investment categories such as stocks, bonds, and cash. Alts include a wide variety of securities as well as tangible assets such as commodities, foreign currencies, real estate, art and collectibles, venture capital, derivative contracts, and more.
Alts typically have a lower correlation with traditional asset classes, meaning they tend to move independently of them, and thus they may provide investment portfolio diversification. They also have the potential to generate higher returns when compared to stocks and bonds, and some are structured to provide passive income to investors. But alts typically include higher-risk assets and strategies, which can be illiquid and harder to track, owing to a lack of transparency.
Alts used to be accessible mainly to high net-worth and accredited investors, but now they’re available to a range of investors, thanks to the emergence of vehicles such as mutual funds and ETFs that include various alts and strategies.
The lack of liquidity for most alts means that determining the fair market value of these assets can be quite challenging. Often there is little by way of public data available regarding price changes or asset appreciation or depreciation, making it difficult to assess historical performance.
💡 Quick Tip: While investing directly in alternative assets often requires high minimum amounts, investing in alts through a mutual fund or ETF generally involves a low minimum requirement, making them accessible to retail investors.
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Types of Alternative Investments
The following list encompasses some common types of alternative investments and alternative strategies available to investors today.
1. Real Estate
• Summary: You can invest in real estate by owning rental property, investing in commercial real estate, industrial real estate, healthcare facilities, and more. Investors can also buy into Real Estate Investment Trusts, or REITs.
• Pros and cons: Although real estate tends to hold its value over time, there are no guarantees. Different properties can be vulnerable to a host of factors including business trends, land values, interest rate risk, and more.
Recommended: How to Invest in Real Estate: 7 Ways for Beginners
2. Commodities
• Summary: Commodities are raw materials that include agricultural products (e.g. grain, meat), precious metals such as gold, silver, copper, energy (including renewables), and more. Generally, investors participate in commodity trading using futures contracts, index funds, mutual funds, or ETFs.
• Pros and cons: Some investors consider commodities a good hedge against inflation and they have the potential to deliver a profit. However, commodities can suffer from any number of unexpected risk factors, from weather conditions to supply chain breakdowns and more.
Recommended: How to Invest in Commodities
3. Private Equity
• Summary: Private equity firms invest capital in companies that aren’t publicly traded, often with the aim of taking over the company. Because PE is a high-stakes endeavor, these opportunities are generally available to high net-worth and accredited investors. Now, however, retail investors can gain exposure to private funds through vehicles such as interval funds.
• Pros and cons: Private equity is considered a high-risk investment, but if a private company goes public or gets acquired, these investments may perform well. The risk with private equity investments is that these are often focused on distressed companies, with a complex track record, and sometimes startups (see Venture Capital below).
Recommended: How to Invest in Private Equity
4. Venture Capital
• Summary: VC investing is a way of putting money into startups with the hope of later gains, though there is no guarantee of a return. Investors can buy a slice of startup or private companies, through equity crowdfunding platforms (which differ from traditional crowdfunding in that investors own equity in the company) and interval funds.
• Pros and cons: Venture capital investing is considered a subset of Private Equity, as noted above. It can be risky because if the startup fails, investors may lose all of their money. On the other hand, if a startup does well, investors may see a significant profit.
Learn more: What Is Venture Capital and How Does It Work?
5. Private Credit
• Summary: Private credit involves direct loans made to companies from non-bank entities. Private credit can be a more expensive way to borrow, but it can be faster for the companies needing capital, and for investors it offers the potential for steady interest payments.
• Pros and cons: Private credit funds tend to see greater inflows when the stock market is underperforming, and they usually pay higher rates than conventional fixed income instruments. The risk here is that most PC funds offer only quarterly redemptions — so they’re quite illiquid — and they can be vulnerable to defaults.
Learn more: Private Credit: Types and Investing Benefits
6. Art & Collectibles
• Summary: Works or art and other types of collectibles (e.g., wine, jewelry, antiques, cars, rare books) can personally appeal to investors, and may grow in value over time. It’s also possible to invest in fractional shares of art, or in shares of an art-focused fund.
• Pros and cons: Investing in art or collectibles may provide a hedge against inflation or other market factors. That said, the price of upkeep, insurance, and maintenance can be considerable. And while some pieces may gain value over time, art and collectibles can also be subject to changing trends and tastes. Fraud is another risk to consider.
7. Hedge Funds
• Summary: Hedge funds offer investors access to alternative investing strategies, like arbitrage, leveraged trades, short-selling, and more. Hedge funds aren’t as heavily regulated as other types of funds, so they’re able to make riskier investments and lean into aggressive strategies, with the goal of delivering outsized returns.
• Pros and cons: While hedge fund managers sometimes deliver a significant profit, they charge high fees and investment minimums that often put them beyond the reach of mainstreet investors. Today, investors may be able to access mutual funds, ETFs, funds of funds, or other vehicles that employ similar alternative strategies.
8. Farmland/Timberland
• Summary: Like many types of real estate, farmland and timberland tend to hold their value over time, as long as they remain productive. This type of property can be similar to commodities in that there is potential profit in the products that come from the land (e.g. produce and timber).
• Pros and cons: Owners of farmland can lease out the land to earn income, which can be profitable for investors. The potential downside of investing in farmland and timberland are the environmental and weather-related risks that can impact both the value of the land and its productivity.
9. Infrastructure
• Summary: Infrastructure refers to the physical structures that economies depend on: roads and highways, bridges and tunnels, energy pipelines, and more. Municipal bonds are one way to invest in infrastructure, as are some types of REITs (real estate investment trusts).
• Pros and cons: As a non-cyclical type of asset, infrastructure investments may offer the benefit of less exposure to market risk factors, steady cash flows, and low variable costs. The risks of infrastructure investments include political and environmental factors that can impact or delay the execution of a project.
10. Foreign Currencies
• Summary: Foreign currencies are an example of an alternative investment that can be highly liquid, and thus easier to trade.
• Pros and cons: Currency trading is known for its volatility, and currency traders often make leveraged trades, assuming a high degree of risk. Retail investors may find it potentially less risky to invest via mutual funds, ETFs, foreign bond funds, and even certain types of CDs (certificates of deposit), although the underlying volatility of most currencies will influence the performance of these investments as well.
💡 Quick Tip: Newbie investors may be tempted to buy into the market based on recent news headlines or other types of hype. That’s rarely a good idea. Making good choices shouldn’t stem from strong emotions, but a solid investment strategy.
Advantages and Disadvantages of Alternative Investments
In sum, alternative investments are certainly worth considering given their potential advantages, but it’s important to keep in mind the possible disadvantages to make the best choices in light of your own goals and risk tolerance.
Advantages
• May offer the potential for higher risk-adjusted returns.
• Are typically not correlated with traditional stock and bond markets, so they may help diversify a portfolio and mitigate risk.
• May have the potential to deliver passive income.
• Some alts may hedge against inflation or interest rate fluctuations.
• May appeal to an individual’s personal interests: e.g., art, wine, memorabilia.
Disadvantages
• Are often higher risk, or can be subject to greater volatility.
• Can be less liquid than traditional investments due to limited availability of buyers and lack of a convenient market.
• Often limited to high net-worth and accredited investors.
• May have higher minimum investment requirements and higher upfront fees.
• May have less available public data and transparency about performance, making it difficult to determine a financial asset’s value.
Recommended: Why Invest in Alternative Investments?
How to Invest in Alternative Investments
As mentioned above, alternative investments used to be limited to institutional investors and high net-worth investors, but they’re now available to average investors through mutual funds, ETFs, and sometimes even through companies’ IRAs.
If you’re thinking about adding alternative investments to your portfolio, finding the right brokerage and/or asset manager can help you incorporate alts into your portfolio in the way that makes sense for your long-term plan. SoFi, for example, is working with knowledgeable asset fund managers in the alts space to provide access to mutual funds across a variety of categories.
Once you’ve identified the types of alternative investments that would suit your goals, your risk tolerance, and your plan (e.g., you might prefer commodities to owning art), you can look for the funds that would help you buy into these alternative asset classes.
Here are some of the more traditional methods to invest in alternatives:
ETFs
An exchange-traded fund, or ETF, is an investment vehicle that enables investors to buy a group of stocks, bonds, commodities, or other securities in one bundle, thus promoting investment diversification and efficiency. They’re widely available, usually through major investment fund companies.
Interval Funds
These closed-end funds are not traded on the secondary market and have limitations on redemptions (among other risks and restrictions). But because the funds are highly illiquid and have infrequent redemptions, fund managers may use alternative investments to pursue higher yields.
MLPs
A master limited partnership, or MLP, is a business partnership that’s publicly traded on an exchange. While an MLP may sound like a company, these partnerships have a different type of structure and are restricted to natural resources and energy-related products and sometimes real estate.
MLPs can provide the liquidity of stocks, but the tax treatment can be complex — and they are higher risk than regular equities.
Mutual Funds
A mutual fund is an investment vehicle that pools money from many investors in order to invest in different securities. Mutual funds may hold any combination of stocks, bonds, money market instruments, or cash and cash equivalents.
They may also include alternative investments, such as real estate, commodities, or investments in precious metals.
REITs
A real estate investment trust, or REIT, is a way of investing in shares of different types of real estate within a single fund. REITs invest in companies that own, operate, or finance a wide variety of real estate types.
Things to Consider When Investing in Alts
Alternative investments are complex, and while the risk may be worth the potential reward for some investors, there are some additional caveats to bear in mind about these assets.
How Are Alternative Investments Taxed?
Unlike conventional asset classes, which are typically subject to capital gains tax or ordinary income tax, different alts can receive very different tax treatments, even when investing in these assets via a mutual fund or ETF. When investing in alts, it’s wise to involve a professional to help address the tax-planning side of the equation.
What Role Should Alts Play in Your Portfolio?
Remember, because alts don’t generally move in sync with traditional asset classes, they may offset certain risk factors. And while alts come with risks of their own, including volatility and lack of transparency, within the context of your portfolio as a whole, alts, and funds that invest in alts, may enhance returns. Some alts can provide passive income as well as gains.
It’s important to know, however, that alternative investments are higher risk, tend to be more illiquid, and less transparent. As such, alts should typically only be one part of your portfolio to complement other assets. Some advisors, for example, recommend up to a 10% allocation for alternative investments, though this number can vary.
The Takeaway
Alternative investments have the potential for high returns and may offer portfolio diversification. The scope and variety of these investments means investors can look for one (or more) that suits their investing style and financial goals. Unlike more conventional investments, alts tend to be higher risk, more expensive, and subject to complex tax treatment.
It’s important to research and do due diligence on any alternative investment option in order to make the best purchasing decisions and reduce risk. While some alternative investments are less accessible, others can be purchased through vehicles such as mutual funds and ETFs.
Ready to expand your portfolio's growth potential? Alternative investments, traditionally available to high-net-worth individuals, are accessible to everyday investors on SoFi's easy-to-use platform. Investments in commodities, real estate, venture capital, and more are now within reach. Alternative investments can be high risk, so it's important to consider your portfolio goals and risk tolerance to determine if they're right for you.
FAQ
Are ETFs considered alternative investments?
Generally no. For the most part, exchange-traded funds (ETFs) are passive investments — meaning they track an index — and typically that index is for a conventional asset class like stocks or bonds. That said, some ETFs track niche parts of the market, including certain types of alternative strategies, including options, long-short strategies, managed futures, real estate investment trusts (REITs), and more.
Are alternative investments worth it?
For some investors, choosing to add alts to their portfolio might be worth it because alternative assets can add diversification (which can help manage risk), and alts may enhance returns over time. But alts also come with their own set of risk factors, including the fact that some alternative assets are illiquid, and are not regulated like other financial products.
How do alternative investment funds work?
Alternative investment funds work in a range of ways. A mutual fund focused on alternative strategies, like derivatives, is likely to be actively managed and employ techniques like leverage or short selling. Before investing in an alternative fund, it’s wise to make sure you understand the underlying strategy, assets, and fees.
What are the key characteristics of alternative investments?
Alternative investments may offer portfolio diversification with low correlation to traditional assets, potentially higher returns, and may provide protection against inflation or interest rate fluctuations. However, they can be illiquid, may have redemption restrictions, and determining their real-world value can be challenging due to limited transparency and public data.
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
An investor should consider the investment objectives, risks, charges, and expenses of the Fund carefully before investing. This and other important information are contained in the Fund’s prospectus. For a current prospectus, please click the Prospectus link on the Fund’s respective page. The prospectus should be read carefully prior to investing.
Alternative investments, including funds that invest in alternative investments, are risky and may not be suitable for all investors. Alternative investments often employ leveraging and other speculative practices that increase an investor's risk of loss to include complete loss of investment, often charge high fees, and can be highly illiquid and volatile. Alternative investments may lack diversification, involve complex tax structures and have delays in reporting important tax information. Registered and unregistered alternative investments are not subject to the same regulatory requirements as mutual funds.
Please note that Interval Funds are illiquid instruments, hence the ability to trade on your timeline may be restricted. Investors should review the fee schedule for Interval Funds via the prospectus.
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