Sometimes, boring is a good thing. And that’s certainly the proven case when it comes to building wealth. We’ve been studying rich people for decades, and have interviewed hundreds of personal finance experts. There’s one universal truth that rings loud and clear when it comes to investing – the more boring and simple your strategy, the higher your chances of success.
“But what about those crypto millionaires that bought bitcoin back in the day? And I heard that Bill Gates just invested billions into farmland… Shouldn’t we do the same?”
Sure, some outliers have gotten uber rich via alternative investments. But that doesn’t mean it should be your primary investing strategy. Alternative investments should only be considered as a very small percentage of your overall portfolio, and only be bought by experienced investors.
In this post, we’re going to talk about some of the most popular alternative investments, their benefits and drawbacks, as well as considerations for including them in your portfolio.
What is an Alternative Investment?
Let’s start by defining “traditional” investments first, then we’ll get to alternatives…
Traditional investments are like the meat and potatoes of your investment portfolio. They’re basically stocks, bonds and cash (or mutual funds and ETFs made up of stocks/bonds). These publicly traded assets have been heavily studied, and are regulated by many governing bodies, like the SEC, Federal Reserve Board, and the FDIC.
In general, traditional investments are considered more liquid, because you can buy and sell them any time to an array of potential buyers. For example, selling a single share of Apple stock within your brokerage account can be done instantly, on your cell phone.
Alternative investments are investments that fall outside of stocks, bonds and cash. It’s when you buy non-traditional assets, like real estate, antiques, art, or peer to peer loans, with the hope that you can sell them later at a higher price. These investments usually promise higher returns, involve more risk, and have far fewer regulations.
The main benefit of alternative investments is that they can help diversify your portfolio. The idea here is that if the stock or bond markets take a dip, it may not impact the price of a fancy vintage wine, or a Picasso painting. Owning alternative investments could, in theory, help hedge your portfolio against standard market volatility.
Another reason people like to buy alternative investments: Because they sound so COOL! Let’s be honest. You’re not gonna impress your friends at brunch by telling them about your index fund holdings inside of your 401k. But you will get a ton of oohs and aahs if you tell them you bought a Rolex 10 years ago and it’s worth triple now. Alternative investments are sexy (the opposite of boring, which is why you should proceed with caution).
Different types of Alternative Investments
There are a ton of options when it comes to alternative investing. None of them are created equal. Here are a few of the most popular alternative investments and our thoughts on them…
Cryptocurrency
Crypto is by far one of the most popular alternative investments in existence these days. Similar to the stock market, you have a lot of choices when investing in cryptocurrency.
At its core, cryptocurrency is a decentralized digital asset. Meaning that it is not backed by any particular authority, like the U.S. government, or any bank or financial institution. Instead, transactions are recorded on the “blockchain,” a.k.a. a digital ledger.
Some of the most popular crypto currencies are Bitcoin, Etherium, and Tether. You buy these currencies through an exchange, like Robinhood or Coinbase. You can also now get exposure to Bitcoin through a regulated Bitcoin ETF.
Our two cents: Certain varieties of cryptocurrency have had more staying power than we originally thought. But it’s still a relatively new investment avenue. Compared to the S&P 500, whose history dates back to 1923, cryptocurrency first hit the market in 2009 with the launch of Bitcoin. Because of its relative newness, we would encourage you to not put the majority of your investment dollars into crypto. Instead, put the vast majority into traditional investments (like index funds), and consider investing a small percentage of your portfolio in crypto if you’re so inclined. But, keep your crypto holdings below 5% of your overall investment holdings.
Real Estate
Real estate investing is one of the most popular forms of alternative investing, and for good reason! Purchasing a rental property and becoming a landlord can provide you with a new stream of income, and help you to build equity.
However, investing in real estate does take time and money. Many folks equate it to having an additional part time job. But, some forms of real estate investing come without needing to do the day to day work. Real estate syndication deals allow multiple investors to come together to invest in a real estate project. This is sometimes known as “crowdfunding.”
One popular crowdfunding platform is Fundrise, which allows folks to invest in specific real estate projects. But, because you’re funding actual physical properties, your money can be locked up for years at a time. Plus, the fees you encounter with many of these crowdfunding platform can be significantly higher than some of our favorite boring options.
Another option for investing in real estate is to invest in publicly traded “REITs,” or real estate investment trusts. This essentially allows you to invest in a company which owns and manages real estate. You can trade these like stocks, and some of the best ones boast relatively low costs.
Our two cents:
Real estate is one of the best alternative investment options for folks who want to diversify their portfolio. Especially when it comes to REITs and owning individual investment properties. When you invest in local real estate, you possess a lot of power over whether or not the value increases. It’s easier to spot underpriced deals.
Plus, you can use sweat equity and make improvements that can drive up the value of the home too. This is a great option for investors who are interested in playing around with alternative investments.
Farmland
Once upon a time, investing in farmland was not very accessible to most folks. But thanks to the internet, it has become more popular over the years for remote investors. In some cases, you can invest in farmland simply by purchasing it and renting it out to farmers, similar to owning an investment property. You can also invest in farmland by purchasing things like farmland REITs, mutual funds, and ETFs.
There are also opportunities to invest in real estate through crowdfunding platforms, like AcreTrader and FarmTogether. However, the barrier to entry is quite high (think $15,000+ minimum investments). And because you’ll be investing in a specific plot of land, you’ll miss out on the diversification you’ll get from ETFs, REITs, and mutual funds.
Our two cents:
If you’re interested in investing in farmland, make sure you do a tremendous amount of research on the market. Minimum investments are high, and that money could probably be better invested elsewhere with much less risk. Again, we’d advise most folks to build a solid portfolio of index funds first, and only invest in real estate that you are knowledgeable about. You might be better suited to farmland if you already know the ins and outs of farming. If that’s not the case, it likely doesn’t make much sense for you.
Peer to peer lending
Peer to peer lending is when you loan out money to another individual or business. Basically, you act as a bank, loaning out your money in exchange for them paying you an interest rate.
You can lend money privately. For example, giving your cousin $10,000 to buy a car, and have them pay you back $500 per month for 24 months. In a deal like this, you would make $2,000 profit and your cousin would pay less money than getting a traditional car loan. Win/win.
More common forms of peer to peer lending is typically done through public websites like Lending Club and Prosper. Businesses, real estate developers, home flippers, etc all apply to these sites and request funding from the public. Projects are assessed and assigned a risk level, and you can choose which people you want to lend to. Riskier deals offer higher interest rates and ROI, but their chances of success are lower. Less risky deals offer a lower return on your investment.
Our two cents: You might think that lending other people money is a surefire way to rapidly grow your money. Banks do it, so why can’t you do it!? But you need to consider that borrowers can (and will) default on their loans sometimes, meaning you end up losing your money completely. You’ll also need to account for any fees, like loan origination fees, and commissions that the websites charge. All in all, we typically don’t recommend peer to peer lending for beginner investors. The returns are quite average compared to the risk that is taken on.
Fine Wine
Investing in wine can take a few different forms. You can go out and physically purchase a fancy vintage wine, store it, and then sell it later on down the road. You can also invest in wines without needing to build yourself a wine cellar, using investment platforms like Vinovest.
Vinovest allows you to invest in fine wine, while they do the heavy lifting of building your portfolio based on your goals and interests, as well as storing that wine for you too.
However, with Vinovest, you’ll need to invest a minimum of $1,000 if you’d like to invest in wine, or $1,750 if you’d like to invest in whiskey. Beyond that, your money will be tied up for between 4-10 years, and you’ll need to pay 2.85% in fees to cover the storage costs of this investment.
Our two cents:
Because of the higher fee structure of this investment, we would only recommend investing in fine wine and whiskey if you are a huge fan of it and you’re already crushing it with your other investments. You have to remember that those fees will eat into your returns, essentially shrinking them by 2.85%. And even if you buy and sell wine yourself, your money will have less liquidity, because it can take time and energy to find a buyer. While it sounds fun, this isn’t an investment strategy we would recommend to new investors. You’re better off drinking the wine and whiskey you like as opposed to investing in it.
Art & Collectables
Buying art is almost pure speculation. You are purchasing it with the sole hope that its value will be higher in the future than it is today. History tells us that rare art appreciates over time. But not all, or even most, art or collectibles do.
When it comes to investing in art or collectibles, you have two options: Buying the physical artwork or collecting items (watches, jewelry, beanie babies, etc.) and storing them for years. Or, invest in items using online investing platforms. Some big art investing sites are Masterworks and Opensea.
There’s a high barrier to entry with buying rare art. I don’t know how many folks you know with $40,000 laying around to buy an original Picasso, but I personally don’t have those kind of funds!
As for digital art, or NFTs (non fungible tokens), you can check out websites like OpenSea, and Rarible. These types of investments are extremely volatile and risky.
Buying art and collectibles typically come with large broker or transaction fees. For example, when you invest in art on Masterworks, you’ll pay a 1.5% annual fee, and they’ll take a 20% cut of the profits when your artwork sells. OUCH.
Our Two Cents: While investing in rare art sounds cool, it’s pure speculation about what it could be worth in the future. We’ve seen some folks make a ton of money on digital art and NFTs, but we’ve seen far more people lose their shirts! In the case of physical art, it can be hard to find a buyer for your expensive investment. If you’re a major art lover, buy art you love because you can afford it and enjoy it, not as an attempt to strike it rich.
Commodities (eg. Gold)
A commodity is a tangible asset or raw material which can be bought, sold, or traded for things of similar value. Precious metals, coal, corn or even sugar fall into this category.
Gold is probably the most popular commodity people first think of when they picture alternative investments. Gold investors can either buy and store physical bars of gold, or purchase gold ETFs within investment accounts. Over the years, gold has become much easier to purchase, with gold coins and bars being available for purchase through retailers like Walmart and Costco. One of the benefits of investing in gold is that it can act as a hedge against inflation, as inflation has been thought to drive the price of gold up.
Raw product commodities (think corn or sugar) are usually purchased in the form of future contracts. These are contracts to buy or sell a set amount of material, at a set price, on a set date. You can buy futures inside ETFs, for example the the Teucrium Sugar Fund (ticker: CANE)
Our two cents: Gold certainly isn’t the worst option out there. But, you aren’t likely to see your money grow as quickly as it would when invested in an index fund like the S&P 500. Since 1980, the average annual return of gold has been just 3.2%, whereas the average return of the S&P 500 sits at 11.7%.
And even if you’re interested in gold for its ability to hedge against inflation, there are more reliable ways to do this. For example, you could invest in I-bonds, which are directly tied to the rate of inflation. At the end of the day, if you want to buy a small amount of gold to diversify your portfolio, go for it. But don’t expect much to happen.
As for future contracts for other commodities, we personally avoid them. They are extremely complex and very volatile.
Private Equity
Generally, private equity involves investing in private companies. Firms will pool money from accredited investors and then invest that money into startup companies (venture capital), buyout of public companies, or to invest in existing businesses.
Our two cents: Most average investors won’t need to worry about private equity since the barrier to entry is so high. To invest in private equity, you’ll need to be an accredited investor, and the minimum investments are typically sky high (in the hundreds of thousands or millions). If you fall into this category, and have a healthy balance of traditional investments, feel free to dabble in private equity. However, be aware that this investment class is generally much more risky. So don’t invest money you can’t afford to lose! And don’t fool yourself into thinking that you need exposure to private equity in order to build wealth. You don’t.
The benefits of alternative investments
So now that we’ve introduced you to a number of different alternative investments, it’s time to talk about whether or not you should invest in them. Here are a few of the benefits of investing in alternative investments.
Potential for higher returns
While stocks and bonds might provide a steady average return over the years, alternative investments have the potential to provide explosive profits. They are extremely volatile, meaning the values typically swing wildly. If you happen to catch a high run, you can net amazing returns.
That being said, killer returns are not a certainty. Possibility and probability are very different things, so it’s always important to look at long term averages. What went up last year might not do so well this year! Never invest money in alternative investments that you can’t afford to lose completely.
It’s exciting
Hey, we get it. Taking the slow and steady approach to building wealth can be a bit of a snooze, even if it is the most reliable way to grow your money. Putting a small amount of money into alternative investments can make investing more fun. Kind of like buying a lottery ticket every year on your birthday.
But is fun what you’re ultimately after? Plan a board game night with friends instead! If you’re trying to build wealth, think long and hard about the role of alts in your portfolio. As long as you only invest a small portion of your money in alternative investments, and have low expectations, you’re exposing yourself to more potential upside while at least minimizing the possible harm you can do.
Alternatives are becoming more accessible
One of the coolest things about alternative investments is that they used to only be available to the ultrawealthy, but are now becoming more accessible. While before it may have been off the table completely for the everyday investor, most folks can now participate in alternative investments to some capacity.
That being said, don’t just trust any online platform that makes investing easy. Some alternative investing platforms are fraudulent (remember FTX?). Only stick with platforms you trust completely, and only use money you are willing to lose completely.
Diversification
Your S&P 500 index fund may be made up of 500 companies, but it won’t expose you to the demand of a Picasso artwork or vintage bottle of wine. Buying alternative investments can help to expose your portfolio to many different markets, increasing the diversification of your investments overall.
Cons of alternative investments
Despite these benefits, investing in alternative investments comes with significant potential downsides. Here are a few negatives to look out for before you invest your hard earned cash…
Decision Fatigue
With so many options and platforms available, it’s easy to become struck with decision fatigue. It’s feasible that you could become overwhelmed and forgo investing altogether. All of these alternatives may end up distracting you from what’s actually important – dollar cost averaging and investing in highly diversified index funds within tax advantaged accounts.
More complicated
Here at HTM, we have a rule. If you can’t explain an investment to an 8 year old, you probably should not be investing in it.
Alternative investments are some of the most complex business models. Investing in something you don’t fully understand is a surefire way to make a naive choice that hurts your finances. So make sure you thoroughly research any investment before taking the plunge.
Higher risk
Another downside of alternative investments is that they are inherently riskier than traditional investments. Many are based on speculation, so it’s hard to calculate a realistic return to expect.
If you have a lot riding on risky investments, you could find yourself in a very bad place if the market takes a nosedive. The S&P500 will always recover after a crash (just give it time). Alternative investments don’t work the same way. You could lose big bucks.
High risk leads to more stress, and feeling the need to check on your investments more often. The best investment strategy is typically to set and forget it so that you don’t let your emotions interfere with your ability to stay the course long term, and riskier investments make it more difficult to do this.
Higher Fees
When considering alternative investments, you’ll need to watch out for higher fees that eat into potential returns. Alternative investments are generally more expensive because they have more overhead. For example, you might be paying for the cost of a temperature controlled room to preserve a bottle of fine wine, or the materials and labor to renovate an apartment complex.
These fees are really sneaky, and can seriously eat into profits. And sometimes they negate any higher returns your investments make! For example, if you earn 12% on an investment, but pay 4% in fees, you’re only walking away with an 8% profit. You took a high risk for the 12% return, but only ended up getting 8% which you could have accomplished more easily with a lower risk investment.
Higher barrier to entry
Another downside is that many alternative investments require a large amount of upfront capital. And you might not be able to buy in small increments like you can with index fund investing.
For example: When you purchase a rental property, you’ve got to fork over a hefty cash down payment. This can take years or decades to save up, and eventually ties up a large chunk of your net worth into a single asset.
Not to mention, some alternative investment options are only available to accredited investors. Many syndication groups, private capital companies and peer to peer lending platforms require accredited or sophisticated investors to participate.
Your money is “locked up”
When you put your money into alternative investments, don’t expect to be able to sell your investments at the drop of a hat. Most of the time, you’ll need to be able to commit to a multi-year investment term. If you end up needing to pull your cash out early, you could lose a lot of your original capital.
If you’re interested in alternative investments, make sure you already have a fully funded emergency fund with 3-6 months worth of expenses. That way, you won’t be tempted to pull your money out early, forfeiting your investment gains.
Should you buy alternative investments?
Given everything we’ve just covered, should you consider investing in alternatives?
First, check out the 7 Money Gears. Before even thinking about alternative investments, you need to make sure your overall finances are on solid ground. Alternative investments lay somewhere around money gear number 7. You’ll get more bang for your buck getting a 401k match or paying off high interest debt than investing money into alternatives.
If you’re already in money gear #7, yes, maybe you can invest a small portion of your portfolio in alternative investments. But, only invest in ways that you completely understand. And only risk money you can afford to lose completely.
The Bottom Line:
When it comes to building wealth, you do not need alternative investments to have a thriving and healthy portfolio. Traditional investments are by far the surest way to slowly grow your money for the future. Investing in index funds will allow your portfolio to be plenty diversified, and the tax advantages of accounts like IRAs and 401ks will help your wealth compound more efficiently over time.
However, if alternative investments interest you, feel free to invest a small portion of your portfolio in them. Start with around 2% of your investable assets. Feel free to ramp that up to as much as 5% over time. If it gets you excited about investing and you can afford to lose that money, more power to you! Alternative investments can be a nice addition to a stock heavy portfolio, but only when the risks are well calculated.
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