What Are Alternative Investments?

What Are Alternative Investments?

Alternative investments don't fall under one of these three traditional asset classes:

• Stocks: Stocks are shares of publicly traded companies that are available to buy and sell via the stock market.
• Bonds: Bonds are debt securities investors can buy from government agencies or companies.
• Cash: Cash is typically held in a savings account, such as a certificate of deposit or high-yield savings account, that allows investors to earn interest.

When you invest in alternative assets, you're putting money into investments that don't fit into one of the above categories.

Types of Alternative Investments

Peer-to-Peer Lending

Peer-to-peer lending (P2P) platforms act as an alternative credit source that connects borrowers with investors who are willing to act as lenders. There's no need for investors to take on any of the responsibilities of acting as a lender, however: P2P lending platforms handle the complexity of issuing loans and collecting payments. As borrowers repay their loans, investors make money on interest. P2P lending can be risky, though most platforms vet borrowers.

Cryptocurrency

Cryptocurrency has become a popular alternative investment. From July 2021 to November 2022, the price of Bitcoin jumped 127%, soaring to over $63,802. That may have translated to a significant payday for investors who got in early. But the cryptocurrency market is unpredictable. Values are constantly in flux, and the market itself is largely unregulated. Trying to predict the right time to buy and sell is difficult, if not impossible, and losses can be significant.

Hedge Funds

Hedge funds pool money from high-net-worth investors. A fund manager then makes investment decisions on their behalf, often focusing on high-risk assets. That may include buying real estate, purchasing stocks and flipping businesses. Investing in hedge funds is risky and typically requires a hefty upfront investment. Large returns are possible, but so are big losses.

Real Estate

There are multiple ways to invest in real estate. Just remember that like the stock market, the real estate market is subject to volatility.

• Buying rental properties: This involves finding and screening tenants, as well as maintaining the properties. You'll likely need strong credit and a 20% to 30% down payment to finance an investment property.
• Buying and flipping real estate: This type of alternative investing often requires a significant upfront investment, especially if you're doing major repairs or renovations. Changing market conditions and interest rates could affect your potential returns.
• Real estate investment trusts (REITs): REITs allow you to invest in real estate without buying an actual property. They're companies that invest in income-producing properties. By investing in a REIT, you'll receive a share of that income through dividend payments.

Private Equity

This is when investors put money into private companies that haven't gone public through an initial public offering (IPO). Instead of buying stock shares, you can provide direct capital to startups or existing companies. In exchange, you'll receive an ownership stake in the business. Alternatively, you might provide loans that are repaid with interest. Private equity investing could pay off if the company does well—or you could lose money if the business underperforms.

Pros and Cons of Alternative Investments

Pros

• Potential for high returns: If your investment works out in your favor, you could secure better returns than you might earn with stocks and bonds.
• Could help diversify your investment portfolio: Alternative assets can help diversify your portfolio and mitigate investment risk.
• May appeal to your interests: If you're interested in real estate, for example, you might enjoy researching properties, renovating homes and preparing them for new buyers.

Cons

• Higher risk: Alternative investments can be volatile, which could lead to significant gains or serious losses. That may be tough to stomach if you have a low risk tolerance.
• Potentially high entry costs: This isn't the case for all alternative investments, but some do require a large upfront investment. For example, you'll likely need significant cash reserves to invest in a hedge fund.
• Possible learning curve: Breaking into a new investment category may require some education. If you want to buy and sell cryptocurrency, for example, you'll need a crypto wallet.

Is Alternative Investing a Good Idea?

Your personal investing style, financial goals and timeline can help determine if alternative investments are right for you. If you're focusing on building your emergency fund, paying down debt or saving for retirement, these riskier assets may not be the best fit. However, they might make sense if you're on strong financial ground and are looking for ways to diversify your holdings. Your interests and unique financial situation should lead the way. Since many alternative investments are unregulated, it may be wise to consult a financial advisor before investing.

How to Invest in Alternative Assets

If you're interested in alternative asset classes, consider which ones you're curious about. For instance, you might have a natural interest in peer-to-peer lending or cryptocurrency. Alternative asset funds can also be a good jumping-off point for investors who are just getting started. For example, there are publicly traded mutual funds that invest in non-traditional assets or use more complicated trading strategies. Similarly, REITs can offer a less risky way to invest in real estate.

The Bottom Line

Alternative assets could help round out your investment portfolio and lead to strong returns, but nothing is guaranteed. They generally carry more risk and are less regulated. Sprinkling them into your investment strategy is probably wiser than going all in—or you may decide they aren't for you.

Either way, maintaining healthy credit is a key part of your financial foundation. Experian allows you to check your credit report and credit score for free, which is important whether you explore alternative investing or not.