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Some of the Common Alternative Investments

It’s no secret that alternative investments are on the rise, and fast. While they currently only make up about 10% of all held assets, they’re growing at a multiplicative rate—particularly with the wealthiest, most successful investors. But no matter where you are in your financial journey, it’s always a good idea to consider diversifying your income and potentially increasing your portfolio’s resilience.

If you’re wondering “Where is the best place to start with alternative investments?” We at i2 Advisors are here to help. In this article, we’ll go over some basics of alternative investments, but we’ll also go over some of the finer details to educate you on types of alternative investments. We’ll explain what it means to diversify by asset class, show you some new ways to attempt to diversify your portfolio, and much more. But first, let’s cover the most important thing to understand about investing:

Why Is Diversification Important?

Simply put, diversification aims to do three critical things for your portfolio:

  • Minimize risks
  • Maximize returns 
  • Create wealth

To illustrate why diversification is important, we’ll use Tom: a fictional investor who’s looking to diversify his own portfolio. Tom currently has all his investment in an airline company, and has done so for decades as the airline industry has grown. While this has proven a profitable investment over the years, any number of unexpected events—say, a pandemic that shuts down travel—can cause Tom to lose a significant amount of his assets, all from a single (albeit catastrophic) event. The airline industry will likely recover, but recovery is not always guaranteed—and neither is the state of the economy.

For investment, diversifying is an example of the idiom “don’t put all your eggs in one basket.” The core concept of diversification is spreading your investments across (and within) multiple asset classes, while also making regular adjustments over time in an effort to maximize returns while minimizing risks. Doing this may lower your risk of losing money, raise your chance of profiting, and make it much easier to create true financial wealth. This is why alternative investments are rising in popularity: they can help with diversification.

Are Alternative Investments on the Rise?

Yes—and fast. According to NASDAQ, the total value of alternative investments worldwide is projected to hit over $17 trillion by 2025; if this comes to pass, that amount would be an almost four-fold increase since 2010.

What Is the Main Advantage of Investing in Alternatives?

Many people are attracted to alternative investments as a way to potentially build long-term, sustainable wealth. This concept is important for retirement, especially as the traditional means of retirement are slowly becoming a thing of the past. Social Security, for example, has long been labeled unsustainable by the Social Security Administration themselves as early as 2003. Investing in one’s future is no longer a “set and forget” concept, but one requires active cultivation of wealth. This has led investors to look for other investment opportunities outside of traditional investments.

What (Actually) Creates Wealth?

Comedian Chris Rock once famously joked that, “Shaq is rich…but [the man] who signs his check is wealthy.” While this was meant as a humorous jab, it’s also a poignant observation about the difference between “accruing wealth” and simply “making money.” But what exactly is the difference between “rich” and “wealthy?” In a word: sustainability.

To understand why alternative assets matter, you need to understand what some have referred to as the three tiers of wealth—and what makes one tier of wealth more sustainable than another. The tiers of wealth are relevant not just in the financial world, but the environmental science world as well. This is because everything that generates wealth originates from natural resources, and wise investment in said resources may lead to financial (and environmental) success.

The three tiers of wealth are as follows:

  • Primary Wealth | Ownership of land or natural resources is what is considered primary wealth. Things like fresh water, ores, oil deposits, coal, or fisheries are some notable examples. The value of primary wealth is in resources.
  • Secondary Wealth | Anything that is created from primary wealth is considered as generating secondary wealth. Mining operations, farms, manufacturers and oil drillers all fall into this category. The value of secondary wealth is in production.
  • Tertiary Wealth | Currency or any of its abstractions are considered to be tertiary wealth. Money, stocks, bonds, credit, and funds are all good examples. The value of tertiary wealth is in potential.

If you imagine “wealth” as a pyramid, then primary wealth would be the wide, solid base that provides structure and stability to the other two forms. The value of tertiary and secondary wealth, then, depends on primary wealth. By extension, tertiary wealth depends on both primary and secondary wealth to determine its value. The theory is that the further away you get from primary wealth, the more volatile your wealth becomes; inflation, stock market crashes, and company losses will devour tertiary wealth first.

With this concept in mind, it’s much easier to see the difference between “rich” and “wealthy.” Rich people have a lot of money, but money itself is not wealth; rather, it is the representation of potential wealth. Assets, then, are a way to convert money into a more stable, reliable form of wealth. If your goal is to build money to a point where you never have to work again, navigating towards primary wealth will be critical to your success—and assets may help you get one step closer to doing just that.

What Are the Types of Investment Alternatives?

Diversification can take on many different forms and methods. If we refer back to our earlier fictional investor Tom, here are just a few levels at which he could diversify, according to Investopedia:

  • Industry | Part of what makes Tom’s investment strategy risky is that it’s in a single industry: the airline industry. As stated before, all it takes is one major event that affects all airlines—such as a pandemic or travel ban—to stifle his earnings. A better strategy would be to invest in at least one other industry, such as manufacturing, healthcare, or agriculture. To take this a step further, Tom could even invest in entirely unrelated industries, so that one crisis would potentially not affect all of his investments at once.
  • Company | Let’s say Tom is set on investing in the airline industry. One of the simplest ways he can still diversify is buying into other airline companies. This reduces risk by not relying on the success (or failure) of one single company. Even the greatest, most profitable companies are subject to collapse, so it’s always good to be prepared.
  • Asset Class | Here is where alternative investments begin to show their value. While the previous two examples are still forms of stock diversification, asset diversification may build an entirely different layer of resilience. Putting money into precious metals, commodities, technology, or even cryptocurrency are some ways Tom can attempt to build a stronger, future-ready portfolio.
  • Borders | Currently, the airline Tom invests in is a globally-traded company. But it’s important to remember that “the economy” is something that can exist at multiple levels of geography. While there is a global economy to consider, states, cities, and even counties can have their own economy that fluctuates. For Tom, it might be a good idea to consider ways he can invest in different geographies.
  • Time Frames | Both short- and long-term investments yield different values, at different times, and at different rates. As such, a good risk/reward balance for a portfolio will include a variety of terms for investments. Tom’s airline company takes several years to complete a full operational cycle, but his favorite clothing retailer LuluLemon makes thousands of transactions each day. Generally, long-term investments are high-risk high-reward, whereas short-term investments are more low-risk and low-reward…but a combination of both can yield success.

How Do Alternative Investment Funds Work?

Typically, alternative investment funds (or alt funds) involve more complex, nuanced approaches than traditional funds such as mutual funds. As detailed by the US Securities and Exchange Commission, alt funds often differ in one or more of the following ways:

  • Objectives | The goals of alt funds will usually subvert the norm in some way, such as seeking a higher profit margin, a quicker turnaround, or above-average risk reduction for the investor.
  • Investment Type | Unlike traditional funds, alt funds often will seek non-traditional forms of investment, such as start-up companies, commodities, or other forms of secondary wealth.
  • Strategies | Rather than seeking straightforward profits, alt funds often will target another goal. A good example is “market neutrality,” or the ability to turn a profit even if the stock market fails.

Are ETFs Considered Alternative Investments?

Given their similarity to mutual funds, ETFs (or exchange-traded funds) could easily be classified as alternative investment funds. ETFs are pools of financial securities that can be sold on an exchange. Typically, they will focus on a specific sector, commodity, wealth type, or some other combination of related investment opportunities. This method of pooling funds for securities is very similar to mutual funds; the difference, of course, is that ETFs can be sold just like stocks.

What Are Some of the Most Popular Alternative Investment Options?

Alternative investments can be a way to diversify your investments, however, they are not without risk. Here are some of the most common forms of alternative investment out there that can help you diversify your investments:

  • Life Settlements | A unique asset class, life settlements involve purchasing an unwanted or unneeded life insurance policy, taking over the premiums, and receiving the death benefit. With a low correlation to traditional financial markets, life settlements are a valuable diversification tool for investors looking to spread risk. Additionally, life settlements can provide relatively stable returns, as they are tied to life insurance policies—which have predictable payout timelines. Furthermore, life settlements often come with a shorter investment horizon compared to other assets, offering quicker liquidity. They can potentially offer a hedge against inflation. It’s important to note that life settlement investments are not without risk.
  • Real Estate | One of the fastest growing alternative investments, real estate is also commonly cited as the most popular form of alternative investment. A good example of primary wealth, real estate investing deals in properties, and the buildings upon them, which are far more stable investments than stocks, bonds, or other forms of tertiary wealth.
  • Commodities | As discussed in the previous section, commodities are a tangible, sustainable way to create secondary wealth. Gold, oil, agricultural products, and natural gas are just a few examples of a near-infinite amount of things you can invest in. Commodity investments can take the form of buying the actual products themselves or trading in their related securities—through methods such as exchange-traded funds (ETFs).
  • Collectibles | The idea of collecting rare and/or coveted items goes hand in hand with wealth. If you can think of an item, there’s likely someone who collects it—and will pay a lot of money for the right one. Collectibles can be good investments for beginners in the financial world, especially those who already have interest in items that are collectibles. Many people think of cars, jewelry, or other high-end items, but even recreational commodities such as wine or trading cards can prove valuable if you know them well. If you’re not convinced of the potential value of collecting something as small as trading cards, consider this: a single card from the Magic: The Gathering trading card game just sold for over $2 million.
  • Hedge Funds | As the name suggests, this type of investment attempts to “hedge” the risk of high-yield investment by pooling larger amounts of capital. Hedge funds are essentially large-scale bets made by a group of wealthy investors, which are then managed by a third party. By collecting from various investors, hedge funds use the leverage of this much-larger amount to magnify profits and expedite turn-around. Historically, this form of investment is strictly reserved for the wealthiest investors through minimum buy-ins and higher fees from fund managers.

Alternative investments, like all investments, carry some degree of risk. Alternative investments, similar to stocks, bonds, mutual funds, and exchange-traded funds, can lose value—even their entire value—if market conditions sour. You should carefully consider the risks of any investment prior to investing.

Want To Learn More About Investment Alternatives?

If you’re looking for ways to diversify your portfolio, it’s always best to contact your financial advisor and/or an expert in the alternative investment field to ensure any strategy or investment meets your needs, goals, suitability, and risk tolerance. For example, if the idea of a life settlement interests you, consider reaching out to us at i2 Advisors. We’re good at what we do, but more importantly, we love doing it because we love helping people live the lives they’ve always dreamed of. Reach out to us or visit our blog for more information on life settlements, or check out our website to see if you qualify.