I have a friend who enjoys horse racing. Well, to be precise, I have a friend who enjoys betting on horse races.
When we go to Las Vegas, we like to spend an afternoon at a sportsbook. We pool our money and he picks a few races. On any typical trip, we sit down with $100 and leave with $90 – $110… with a few close races to make it exciting. Not a bad way to spend an afternoon.
While I enjoy an afternoon hanging out with friends at a sportsbook, owning a race horse is one of the income producing assets I’m
probably never going to own.
Like with owning a boat, it’s more fun knowing someone who owns a horse rather than actually owning one. (I don’t know anyone who owns a horse, but I can attest to the boat!)
That said, I have been keeping my eye out towards alternative investments.
It’s important to know what’s out there and I enjoy reading about weird alternative investments. Equities are good investments but they are also boring. How many articles about how low-cost Vanguard funds can you read?
What is an Alternative Investment?
What is an alternative investment? An alternative investment is anything you can’t buy in a standard 401(k). Stocks, bonds, and cash are not alternative investments.
Many of these are not regulated by the Securities and Exchange Commission (SEC). Some may file their offerings with the SEC but that’s because they are considered “exempt offerings.”
For most people, their biggest “alternative investment” is real estate. You can own real estate in a 401(k) through REITs and mutual funds, but you can’t own the deed to a property. You have to set up a special structure if you want to invest your retirement savings in property. You also can’t own gold bullion, art, or other collectibles.
Some types of alternative investments will require you to be an accredited investor. To qualify as one, you need to be able to satisfy a few conditions such as net worth and income. Some investment platforms will need to certify you as an accredited investor while others will take you at your word.
Do You Need Alternative Investments?
The key to investing is diversification.
You don’t want to be overexposed in any one area.
It’s why experts recommend you get an appropriate mix of stocks and bonds. It’s also why you need a good mix of domestic and international, so the woes of any one nation don’t sink your fortunes. It’s also why experts recommend some part of your portfolio to be in alternative investments.
In theory, alternatives aren’t supposed to be strongly correlated with the stock market or many external forces. They may be negatively correlated, as often is the case with gold and the stock market.
1. For the average retail investor, we think of investing as stocks and bonds. What’s the role of alternative investments in their portfolio?
Alternative investments help to diversify a portfolio. They make portfolios more efficient by including stocks and bonds plus an allocation to some alternative investments. This helps to reduce portfolio volatility and provide additional sources of return. Some types of alternative investments can also provide downside protection when markets fall. Diversification, downside protection, and enhanced returns are the primary benefits and roles of alternatives in portfolio construction.
2. Many investors believe alternative investments are only for accredited investors – is that still the case? How has that changed over the years?
Traditionally, that is correct, but only if you are talking about private funds. Private funds such as hedge funds and venture capital funds are typically offered via private limited partnerships under a safe harbor exemption restricting their sales to certain high net worth individuals and institutions who meet accreditation criteria. Over the past several years a whole range of alternative investments are now available to the public in registered vehicles or via exchanges or crypto solutions that do not require any special accreditation.
3. If someone is not yet accredited, what’s the best way for them to get exposure into these investment types?
Here are some examples. Mutual funds and listed business development funds that offer exposure to hedge fund strategies and credit strategies are available to anyone today. These products are more highly regulated and offer better liquidity than private funds. There are even some mutual funds being offered today that provide exposure to private equity deals and firms. In addition, exotic alternative investments like storage units or litigation funding can be purchased using ETFs that are listed on the NYSE. Some, even more exotic investments like trading cards, luxury handbags, and vintage sneakers as well as many NFTs can now be bought and sold peer to peer, on exchanges set up to match buyers and sellers, or using crypto assets that leverage blockchain technology.
How Much Should be in Alternative Investments?
This is a challenging question because alternative investments are so different. They are not perfect substitutes for one another.
Miscellaneous investments may be a better term! Real estate is nothing like art. Art is nothing like mineral rights.
That said, experts will say that you should be anywhere from 7-12% in alternative assets. Real estate is an alternative investment. For many, home equity is a huge percentage of their net worth… so many people already have huge exposure to real estate and not know it.
When it comes to investments, I’m a boring plain vanilla type of guy.
But it would be fun to see what’s out there.
What are the Best (and Fun) Alternative Investments?
Now to the fun stuff!
I’m going to present a list of fun alternative investments.
Some of these are a little odd… but that’s part of the fun. Remember, this is not an endorsement of any of them! 🙂
I discuss general real estate in the next section but farmland is a special subclass that deserves special mention. It’s been traditionally very difficult to invest in farmland, especially farmland because there haven’t been many platforms that appeal to that market.
Farmland has had a very good run since 1990 and $10,000 invested in farmland in 1990 would be worth $199,700 today. The S&P 500 grew about 13X over that same period (including dividends).
There’s on new company that is hoping to change that – they are named AcreTrader.