What You Need to Know About Alternative Investments
True to their name, alternative investments resemble the kinds of investment products we know very well, like stocks and bonds, yet there’s something, well, different about them. They don’t quite fit in. That’s not to say that there isn’t a place for alternative assets in your portfolio, in fact, they can be advantageous to own. Let’s take a closer look at some of the common alternative investments available today.
Benefits of Alternative Investments
The primary benefit of an alternative investment is that it can provide you with diversification in your portfolio. You can achieve diversification in the stock market, but what happens when the entire market drops? The good news is that when some asset classes are falling, others are rising. That’s why it can be beneficial to hold some investments with little correlation to the stock market. Bonds are a good example, as are many alternative investments.
Drawbacks of Alternative Investments
Most alternative investments can suffer from any combination of the following: a lack of liquidity, extreme volatility, and having a high barrier to entry. For example, real estate lacks liquidity due to its prohibitive cost and the length of time it takes to sell. And unlike real estate, cryptocurrency has no tangible value and is highly speculative.
Where Do Alternative Investments Fit in My Portfolio?
Before exploring the various alternative investment options that exist today, it’s important to understand where they fit in a well-diversified investment portfolio. The short answer is that for the vast majority of investors, an alternative investment should never be considered as a core portfolio holding, with the possible exception of real estate. There’s simply too much risk to expose more than 10 or 15% of your portfolio to so much risk.
Instead, I recommend sticking to low-cost mutual funds, ETFs, or stocks in a well-balanced portfolio and allocating a small overall percentage to one or more alternative investments.
Types of Alternative Investments
While not an exhaustive list, here are seven investment assets available to investors that you may not have considered for your portfolio.
Commodities are another term for basic goods and raw materials that various industries use to manufacture commercial products. Examples include grains, natural gas, silver, gold, and beef. Investors access commodities by purchasing them on a commodity exchange. The largest commodity exchanges in the U.S. include the New York Mercantile Exchange, the New York Board of Trade, and the Chicago Mercantile Exchange. Perhaps the simplest way to buy commodities is by purchasing futures or an associated ETF.
If your preference is to buy gold, you can now use an app on your smartphone. Vaulted lets you invest in 99.99% pure gold bars manufactured and stored by the Canadian Mint. If you choose, you can have your gold bars delivered to your address via FedEx. The gold is certified conflict-free and insured against theft, loss, or damage.
It only takes a minute to open your account, and as soon as you fund it via an electronic transfer from your bank chequing account, you are ready to trade. According to Vaulted, the buy and sell price is never more than 1.8% above the wholesale rate. There is a .40% annual maintenance fee, however.
Cryptocurrency, or crypto for short, is a digital currency that doesn’t exist in a physical form. One of the draws of cryptocurrencies such as Bitcoin or Ethereum (there are hundreds of different types) is that governments cannot regulate it, making it difficult to track. You can purchase crypto through online exchanges and at dedicated bitcoin ATMs. The process for buying and selling cryptocurrency can be tricky, though recently, Wealthsimple has made it a lot easier with the launch of their Crypto mobile trading platform. Cryptocurrency is highly volatile and speculative, which is why I cannot recommend it as a core investment holding.
3. Fine Art Investing
This has to be one of my favourite alternative investments. Through a company called Masterworks, you can purchase shares in iconic works of art, actual physical paintings by master artists. According to Masterworks, fine art investing has a very low correlation to most other asset classes, such as the stock market, making this an ideal way to build diversification in your portfolio.
Here’s how it works, in a nutshell. Masterworks sources art that they feel has a high potential to increase in value. They then purchase the art and file a circular with the Securities Exchange Commission (SEC), which means anyone can invest in the art. Eventually, Masterworks sells the artwork, and shareholders receive the profit, minus commissions and fees. Have you ever dreamed of owning a Banksy or a Warhol? Well, this might be your chance.
4. Forex Trading
Forex investing, also known as foreign exchange, involves exchanging funds from one currency to another to benefit from fluctuations in the exchange rate. Most individual forex traders buy and sell foreign currency on something called the spot market. Forex trading is highly decentralized and liquid due to its importance in the global economy. Anytime goods move across international borders, traders must exchange foreign currencies. You can participate in forex trading anywhere you can exchange money in real-time, including through online brokerages like Questrade.
5. Hedge Funds
This may be the only investment on the list that can’t be purchased by the average investor. A hedge fund is an actively managed investment portfolio that uses complex investment strategies, like leveraging, long, short, and derivative positions, to generate positive returns, even when markets are falling. Most hedge fund investors must possess a high net worth and income because of the inherent risks, although the purchase minimums alone dictate who can participate. The initial investment in a hedge fund typically starts at $500,000 and can be as high as $1,000,000.
6. Peer-to-Peer Lending
Chances are you’ve heard of crowdfunding sites like Kickstarter or GoFundMe. Well, you can get involved in another type of crowdfunding, and this one will pay you interest. Peer-to-peer lending, also known as P2P, occurs when individuals pool their money together and lend to borrowers in the form of loans that are very similar to what you would traditionally get from a bank.
Over time, the borrower repays the loan with interest, and the profits split between the various lenders. P2P lending companies like Lending Loop and Peerform provide a platform for connecting borrowers with individuals wanting to lend money. As with any bank, interest rates on the loans vary depending on the amount and the borrower’s risk profile. Higher risk loans offer higher returns but also a greater chance of default.
7. Real Estate
You may wonder why real estate investing would be included in a list of alternative investments. After all, thousands of Canadians invest in real estate, either through the ownership of rental properties or by flipping investment properties for a profit (hopefully). But as mainstream as real estate investing may appear, it shares two characteristics with other alternative investments: it’s illiquid, and it comes with a higher barrier to entry than stock or an ETF.
Real Estate Investment Trusts (REITs)
It’s possible to invest in real estate without having to buy the physical property. Real Estate Investment Trusts, or REITs, hold income-producing real estate in residential and commercial sectors. Investors can own shares of a REIT by purchasing company stock or through a mutual fund or Exchange Traded Fund (ETF).
What Are the Best Alternative Investments?
There is no single best alternative investment. If you’re interested in diversifying your portfolio, you want to look for an asset class you are comfortable with which complements your primary investments. Many Canadians invest in real estate because it’s something they can understand; it has the potential to provide cash flow. It’s a tangible asset you can put your hands on, unlike cryptocurrency, which is completely virtual.