As you get more immersed in the investing world, you will likely hear the somewhat confusing term “alternative investments.” The problem with this term is that it is a large category that covers many different types of investments. In short, alternative investments are those asset classes other than stocks, bonds, or cash. Typically, these investments are not very liquid, which increases the risk involved with investing in them. A large number of asset classes fall under the umbrella of alternative investments and they can look and act very different from each other. You should take some time to learn about these different assets since they are becoming increasingly available to individual investors and could play an important role in your portfolio, especially since they tend to have a low correlation with the movement of standard asset classes. Some of the key alternative investments to know include:
The category of commodities includes real assets, most of which are natural resources like gas, oil, agricultural products, or precious metals like gold. Notably, commodities are among the oldest forms of investment with exchanges dating back thousands of years. People tend to invest in commodities as a hedge against inflation since their value rises in line with supply and demand. Value tends to increase during periods of high inflation as supply decreases and demand increases. However, this sort of price movement is not guaranteed, so you need to be cautious when you invest in commodities and do some research on historic performance.
The largest asset class in the world is real estate. This unique class has features similar to both equities and bonds. As with equities, the goal is to increase the value of the asset over time, a process called capital appreciation. Like with bonds, you can charge rent and receive cash flow from the asset. One of the biggest challenges in real estate remains valuation and the investors who perform the best in this category understand when to apply various valuation strategies based on circumstances. Doing this helps them identify the best deals to help them meet their goals. Many valuation strategies exist, including comparables, income capitalization, and discounted cash flow. Each of these has its own benefits and limitations.
Another broad category of alternative investment is private equity. This category includes any capital investment in a private company not listed on a public exchange. Venture capital, growth capital, and buyouts all fall within this category. These represent different types of investments at various stages of growth for the company. Typically, private equity investments are made by specialty firms that can provide much more than capital. These firms often help find talent, provide mentorship to leadership, and give important advice on growth moves.
The category of structured products typically involves fixed income markets and investments that pay dividends. Some popular structured products include credit default swaps and collateralized debt obligations. These products tend to be very complex and can involve considerable risk. However, these products are also very customizable, which makes them ideal for people with particular needs. However, you would need to find someone to issue that particular product. Investment banks will often make these products for hedge funds, retail investors, and other organizations.
The term private debt refers to investments that are not financed by banks or traded in the market. Both public and private companies can use private debt when they need more money to help the business grow. Companies that issue this capital are referred to as private debt funds and they make money through interest payments on the money and the repayment of the loan. Essentially, private debt is like making a bank loan as an investor with a mutually agreed upon interest rate. This investment comes with significant risk since there is always the chance that companies will default on the loan. While private debt does not get traded on exchanges, these loans can be bought and sold between investors, which may happen if they become distressed.
CollectiblesMany different items get collected, including cars, wines, toys, art, stamps, and coins. When you invest in collectibles, you purchase the actual asset and hold onto it with the hope that it appreciates in value over time. For many people, investing in collectibles is fun, especially if they have some interest in the particular item. However, this strategy comes with a lot of risk since you often need to pay a considerable amount of money upfront and receive no dividends. The asset could be destroyed or decrease in value so that you actually lose out on money once you sell it. To really make money through collectibles, you need to be an expert on the particular asset you are purchasing.