Sometimes it’s good to be different not just in life but also in your investments. Many of us are invested in the stock market through retirement plans or directly owning stocks. Nearly 46% of people in the US hold mutual funds. Approximately 56% own stocks. However, many of us are concentrated in these asset classes.
Our retirement portfolios consist primarily of stocks and mutual funds that invest in stocks. Some of us own bond mutual funds or bonds and almost all of our cash. Together, stocks, bonds, and cash are the core investment for most small investors. But few of us own alternative investments.
But diversification is a good thing when it comes to investing. Other types of investments can provide diversification to portfolios overly concentrated in equities, bonds, and cash. Sometimes alternative investments can provide excellent returns but sometimes not. There are many types of alternative investments, and some are obscure and not easily accessible to retail investors. For instance, artwork and collectibles are complicated for the average retail investor to purchase.
That is because artwork and collectibles are subject to counterfeiting, are illiquid, and determining valuation is difficult. However, here are five types of alternative investments to look at that are more common. One note of warning, though, these investments are not for everyone since some can be riskier than stocks, bonds, and cash.
Risks for Alternative Investments
No discussion about alternative investments is complete without considering the risks. First, many alternative investments but not all are relatively illiquid, meaning there is no exchange or ready market for them, making alternative investments challenging to buy and sell. Hence, unlike Amazon stock, a publicly traded stock on stock exchanges, it is sometimes difficult to value an alternative investment. Second, there are a limited number of buyers and sellers.
Next, regulation is more limited for some alternative investments. So, you need to do more research and diligence before jumping in. Lastly, many alternative investments are available only to accredited investors. If you don’t have the income or wealth to absorb a potential loss, you should probably think twice.
5 Types of Alternative Investments
The first alternative investment on this list is gold. Gold has a long history as an investment due to its status as a precious metal. Today, gold is classified as an alternative investment, but it is easily traded. Most people don’t own gold coins or gold bars. Indeed, a recent survey states that only 10.8% of Americans own gold. A percentage that is low compared to stocks and mutual funds. Some of you may own 14 ct or 22 ct jewelry. However, this is not typically an investment but rather to wear.
Gold has some advantages as an investment in that it is considered a store of value, which is especially true during times of inflation when the price of gold goes up as other prices rise. In addition, governments around the world buy and hold gold as reserves. Fort Knox has about 147.3 million ounces of gold held at a book value of $42.22. Other countries own lesser amounts in their reserves. The spot price of gold is approximately $1,758 per ounce today. The dollar value of the Fort Knox gold reserves is about $260 billion.
Most of us don’t want to buy and hold gold bars. There are other ways to buy gold, including mutual funds and ETFs backed by gold holdings. Gold had a good run in 2019 and 2020 but is down year-to-date in 2021. Gold is not for everyone to own but if you feel it has a place in your portfolio, do some research.
Cryptocurrencies are the second alternative investment on this list. They are a relatively new asset class. What was once an obscure asset class has become increasingly mainstream. It is possible to buy cryptocurrency on fintech platforms. You can also mine cryptocurrencies if you can program and own the hardware. Today, there are hundreds to thousands of cryptocurrencies, and the total market is estimated at over $1 trillion. Cryptocurrencies are not all the same.
They differ in the level of acceptance, liquidity, and ability to be used for purchases besides just trading. China, the second-largest economy, has made all cryptocurrency transactions illegal and has banned them. Other countries that have stated cryptocurrencies are illegal for transactions include Russia, Vietnam, Bolivia, Columbia, and Ecuador.
Bitcoin (BTC) is the most well-established cryptocurrency and has the longest track record. In addition, Bitcoin has more major financial institutions involved leading to a measure of respectability and regulatory outline. Some large US tech companies have added Bitcoin to their balance sheet.
Bitcoin is viewed as similar to gold in that it is uncorrelated with equities and bonds and can provide diversification. You can also use Bitcoin instead of cash for purchasing goods. El Salvador is the first country to adopt Bitcoin as a legal tender.
Other relatively common cryptocurrencies include Bitcoin Cash (BCH), Ethereum (ETH), Cardano (ADA), Dogecoin (DOGE), Binance Coin (BNB), and Polkadot (DOT). Ethereum is the second most common cryptocurrency with an 18% market share after Bitcoin’s 47% market share.
Dogecoin was reportedly started as a joke but has gained in popularity. Dogecoin has a faster mining rate than Bitcoin, and there are already 130 billion in circulation. The number of Bitcoins is capped at 21 million.
Investors in cryptocurrency should be aware of the risks. The asset class is very volatile, and there is significant regulatory risk. Cryptocurrencies are not for everyone.
Special purpose acquisition companies (SPACs) have been around for years. But their popularity rose in 2020 and 2021 after a time where many forgot about them. This resurgence is due to the success of a couple of well-known startups going public via the SPAC route, including Richard Branson’s Virgin Galactic (SPCE) and the online sports betting company Draft Kings (DKNG).
What is a SPAC? They are also known as blank check companies. Startups can choose this route to go public instead of an initial public offering (IPO). The advantage is that there are fewer regulations and financial disclosure requirements. A SPAC is formed by investors who raise capital. Retail investors probably cannot invest at this stage. Most of the investors are venture capital and private equity firms. After the SPAC raises capital, it files for an IPO and goes public. Retail investors can buy shares. At this point, the money raised as the capital before the IPO is used to acquire a privately held company.
There are risks to SPACs. The main one is that investors do not know ahead of time which company the SPAC will acquire. The SPAC is a holding company and has no operations. The second significant risk is that SPACs have fewer regulatory and financial disclosures. There are other risks, and thus SPACs are not for everyone.
Real estate is an alternative investment. Your primary home does not count as an investment. However, many investors own residential rental properties to generate passive income. Other investors buy, fix, and flip real estate. Real estate is also an inflation hedge, and there are potential tax benefits.
This approach is a viable and accepted way to millionaire status, as illustrated by many millionaire interviews. You need some capital to invest in rental properties, and there are risks. Real estate can decline in value, such as during the sub-prime mortgage crisis. There are also headaches related to maintenance, insurance, and tenants.
Real estate investors can also own commercial rental properties. But buying office buildings, apartment complexes, warehouses, storage facilities, cell phone towers, and other types of buildings is difficult. Investors typically need more capital and knowledge of the market. An alternative method of taking a stake in commercial real estate is buying real estate investment trusts (REITs).
REITs are equities that are publicly traded on stock exchanges. They are pass-through entities and distribute 100% of their taxable income as dividends. Hence, REITs tend to have high dividend yields. As a result, the stock price of REITs can increase, adding to returns. But investors should know that the dividend tax rate of REITs is the same as regular income.
However, the unique structure of REITs adds risk to investors. REITs can be volatile and have poor returns during recessions. The sub-prime mortgage and the COVID-19 pandemic are examples of when REIT stock prices plummeted. REITs cut or suspended their dividends during the COVID-19 pandemic and the sub-prime mortgage crisis. As a result, investors relying on REITs for income were severely punished.
That said, REITs have had periods of high returns and outperformed corporate bonds, and provided diversification.
The fifth alternative investment in this list is commodities. Commodities are tangible assets. They can be bought and sold on exchanges, much like equities and bonds. Commodities are another alternative investment that is an inflation hedge. Their prices tend to rise during times of inflation. However, their prices can decline, too, as supply outstrips demand. Commodities include precious metals, crude oil, natural gas, corn, soybeans, coffee, sugar, soybeans, wheat, etc.
Most retail investors will not directly buy and sell commodities or commodity futures or options. Instead, they will probably buy and sell commodity exchange-traded funds (ETFs). ETFs have made it much easier for retail investors to participate in this part of the market.
Disclaimer: Dividend Power is not a licensed or registered investment adviser or broker/dealer. He is not providing you with individual investment advice. Please consult with a licensed investment professional before you invest your money.
Prakash Kolli is the founder of the Dividend Power site. He is a self-taught investor and blogger on dividend growth stocks and financial independence. Some of his writings can be found on Seeking Alpha, TalkMarkets, ValueWalk, The Money Show, Forbes, Yahoo Finance, Entrepreneur, FXMag, and leading financial blogs. He also works as a part-time freelance equity analyst with a leading newsletter on dividend stocks. He was recently in the top 1.2% (98 out of over 8,252) of financial bloggers as tracked by TipRanks (an independent analyst tracking site) for his articles on Seeking Alpha.