An alternative investment is a financial asset that does not fall into one of the traditional asset classes: stocks, bonds, and cash.
As an investor, you purchase assets with the expectation that they will generate some profit or income for you in the future. Whether you’re new to investing or a veteran investor, it’s a good idea to be clear on the types of assets or asset classes that may be available to you.
The most common and broadly accessible asset classes are stocks, bonds, and cash (or cash equivalents such as bank certificates of deposit, US government Treasury bills, and bankers’ acceptances). These are traditional investments.
But the world of investing is much wider and more diverse. Besides traditional investments, there are investments commonly known as “alternatives” or “alts”. These include venture capital, private equity, hedge funds, real estate, and commodities as well as real assets such as precious metals, rare coins, art, and antiques.
Why invest in alternatives? Though they tend to involve more risk than traditional investments, alternative investments can deliver higher returns. Think of Ram Shriram, who invested around $200,000 in Google when it was still an early-stage startup and made over $22 million by selling some of his shares at Google’s IPO. Another key benefit of alternative investments is that they perform with a low correlation to stocks and bonds, which means that they are good vehicles for portfolio diversification. That means that if your investment portfolio includes not only stocks and bonds but also alternatives, then when the stock market takes a downturn, some of your investments (namely, the alternative ones) won’t depreciate. Additionally, some alternative investments, such as commodities and real estate, provide protection from inflation, which hurts the purchasing power of paper money (that’s why many pension funds and endowments typically allocate a small part of their portfolio to alternative investments).
Alternative investments are typically both less liquid and more difficult to value than traditional investments since they are not publicly priced or traded. While illiquidity may be more of a virtue than you might initially think, the fact that the value of alternatives is often difficult to assess means that investors need to rely on trusted professionals or acquire the relevant knowledge and expertise themselves.
Because of their degree of risk and the knowledge and expertise required to assess them, most alternative investment assets are held by institutional investors or accredited individual investors. However, non-accredited retail investors can access alternative investments through alternative mutual funds and exchange-traded funds.