There has been a lot of talk over the last few years about alternative investments and rightfully so. The wealthy, endowments and pension funds have been using them for years to diversify their portfolios, generate income and help manage the risk of the stock market.
If you are not familiar with what they are, an alternative investment (generally speaking) is considered to be something other than a traditional investment.
While a traditional investment is basically anything relating to US and international stocks and bonds, an alternative is something entirely different. They are a Portfolio Diversifying Investment (PDI). They don’t necessarily replace traditional investments but are added to a portfolio to create diversification beyond what can be achieved using ETFs, mutual funds or stocks and bonds.
Many traditional investments talk in terms of historical or hypothetical rates of return. However, the primary goal for using many alternatives is to grow wealth through income or generate cash flow for fulfilling budget requirements.
While you will hear such things as an 8% rate of return when describing a traditional investment, an alternative may reference an 8% yield. On the surface this may seem to be semantics but suffice it to say that these are two very different things.
Up to now, alternatives have traditionally been reserved for the wealthy due to their high minimums and other requirements. This has a lot to do with the fact that the wealthy often have access to more advanced financial advisors, direct relationships with private equity firms and hear about investment opportunities that the average person will never hear much about or pay attention to.
The wealthy seem to be more educated about their options and realize the level of risk that exists within traditional investments leading them to seek to find “alternatives.”
Meanwhile, the most common mistake I find that novice investors make is with their definition of diversification. For many, diversification means having a handful of mutual funds either in their IRA or 401(k) plan with little consideration for anything else.
The primary reason I believe this is true is simply due to the fact that 401(k), 403(b) and 457 plans only have mutual funds available. So, many investors are familiar with these types of investments offered through their employer and feel limited to using this form of investment.
However, investment opportunities exist in many different forms and in many different categories. I will not get into all of the statistics and descriptions in this article but will underscore the fact that International and US stocks and bonds combined only make up five to six asset classes out of a dozen or so.
The good news is that more and more alternative investment opportunities have become mainstream and have been made available to accredited investors in recent years through a lowering of minimums. (An accredited investor is anyone with a liquid net worth of one million dollars or more excluding a residence.)
If you are an accredited investor and have questions about how alternatives work and how they may contribute to rounding out your portfolio let me know.
Alternative Investment Funds represent speculative investments and involve a high degree of risk. An investor could lose all or a substantial portion of his/her investment. Investors must have the financial ability, sophistication/experience and willingness to bear the risks of an investment in an Alternative Investment Fund.