Alternative Investments are any investments other than stocks, bonds, and cash including exotic assets such as a Pablo Picasso collection. Private equity or venture capital, hedge funds, real property, commodities, and tangible assets are all examples of alternative investments. They are of complex nature, have very little regulation, and usually a high degree of risk. Most alternative investments are unregulated (by the SEC or otherwise). They have two attractive attributes: they can sometimes generate superior returns, usually over longer term and they may be uncorrelated to the stock and bond markets, which means they can help to diversify your portfolio and reduce overall risk.
Most alternative assets are fairly illiquid, especially compared to their conventional counterparts. For example, investors are likely to find it considerably more difficult to sell an 80-year old bottle of wine compared to 1,000 shares of Apple Inc., due to the limited number of buyers. Investors may have difficulty valuing alternative investments, since the assets, and transactions involving them, are often rare. For example, a seller of a 1933 Saint-Gaudens Double Eagle $20 gold coin may have difficulty determining its value, as there are only 13 known to exist.
Many alternative investments have high minimum buy-in and fee structures, especially when compared to Index Funds, Bonds and Mutual Funds. These investments also have less opportunity to publish verifiable performance data and advertise to potential investors.
Transaction costs can vary wildly depending on the traded asset, for example gold has fairly low transaction costs, low tax, no seller fees. But fine art will have a high buyer/ seller cost such as auction house fees. Assets such as real estate and classic cars will also have maintainice and/or repair costs attached in order to realise the full value.
Gold produces very little income and is not a critical resource. Warren Buffett said, “Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again, and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”
While it is possible to profit from investing directly in residential property, most of us can’t afford to diversify by owning a slew of houses or commercial property. However, it is possible to invest in publicly traded Real Estate Investment Trusts (REITs). They provide a no-hassle, low-cost way to diversify broadly, both geographically and across different types of property without the associated costs of owning physical property.