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What are Alternative Investments?

Stocks, bonds, and cash are considered main stream investments. Alternatives encompass investment assets or methods other than stocks, bonds, and cash. Many alternatives are available for investment.

Real estate, precious metals, private equity, and art are a few of the assets in the alternatives category. Alternative methods include long-short strategies. All aim to be non-correlated to the stock and bond markets. This means that they expect to perform differently than stocks and bonds. Alternatives are popular because of this non-correlation since it is assumed to provide better overall returns.

The idea is that as stocks tank, alternatives will shine or, at least, protect the portfolio from losses. Alternatives have fared better at times than the stock market. Some have returned positive gains when stocks were negative. Some suffered losses, but not as steep as stocks.

Each alternative category has its own advantages and disadvantages. Many such as private equity require a large ($500,000 or more) initial investment. These investments take years to realize a gain. They are illiquid, meaning that you will not be able to sell easily. Private equity involves investing in private companies. Gains come when the company goes public or is sold. This has been the domain of high-net worth investors. One reason being that they have the funds to weather an illiquid and riskier investment.

Commodities are another alternative investment. They are more accessible to a broader range of investors with the introduction of ETFs. Exchange-traded funds exist for most commodities. You can invest in oil, gas, gold, and soybeans, among others. ETFs provide broader diversification, but commodities tend to be more volatile. Their prices can fluctuate radically daily.

Hedge funds are listed as alternatives. But they are not an asset class. Hedge fund is a general term for various alternative assets and strategies. A hedge fund manager may concentrate on one type of asset. The manager may choose to shift from one asset class, or strategy, at his discretion. Hedge funds have considerable leeway in how they choose to invest. Traditional mutual funds are limited in their options and strategies.

Are alternatives a good investment? Opinion is mixed. Many believe alternatives to be too risky and poor performers. Others feel they can add to a portfolio. The fact is that many alternatives are unavailable to all but the wealthiest of investors. The ones that are available can have a small place in a well-planned out portfolio. Emphasis should first be on a good stock/ bond/ cash mix. Then alternatives can be considered.

One final point. Do not expect alternatives to always provide positive gains. This applies even when stocks and bonds are down. Alternatives run in their own cycles. Sometimes they do well and sometimes they don't. Watch the fees they charge too. They need to perform well to overcome the high fees that accompany some of the alternatives.


Are you interested in a simple portfolio of traditional investments to save for retirement? Please check out my book on building a simple retirement portfolio that is available at Amazon.com:

Investing $10K in 2014 (Sandra's Investing Basics)


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