When most people think of investing, they generally think of traditional investments—namely stocks, bonds, and cash. Whether it’s the index fund in your 401(k) or the cash in your savings account, these traditional investments are common for most individual investors.
But that's only part of the picture. There's another category of investing beyond traditional investments, called alternative investments.
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Alternative investments are asset classes that aren’t stocks, bonds, or cash. These kinds of investments differ from traditional investment types because they aren’t easily sold or converted into cash. It’s also common for alternative investments to be referred to as alternative assets.
One of the most dynamic asset classes, alternatives cover a wide range of investments with unique characteristics. Many alternatives are becoming increasingly accessible to retail, or individual, investors—making knowing about them increasingly important for all types of investors and industry professionals.
These types of investments can vary wildly in their accessibility and structure, but they share a few key characteristics:
- They're more lightly regulated by the US Securities and Exchange Commission (SEC) than traditional investments.
- They're illiquid, meaning they can’t be easily sold or otherwise converted to cash.
- They have a low correlation to standard asset classes, meaning they don’t necessarily move in the same direction as other assets when market conditions change.
While alternative investments share these key traits, they're also a diverse asset class. Here are seven types of alternative investments everyone should know, what makes them unique, and how to think about them as investment opportunities.
7 Types of Alternative Investments
1. Private Equity
Private equity is a broad category that refers to capital investment made into private companies, or those not listed on a public exchange, such as the New York Stock Exchange. There are several subsets of private equity, including:
- Venture capital, which focuses on startup and early-stage ventures
- Growth capital, which helps more mature companies expand or restructure
- Buyouts, when a company or one of its divisions is purchased outright
An important part of private equity is the relationship between the investing firm and the company receiving capital. Private equity companies often provide more than capital to the firms they invest in; they also provide benefits like industry expertise, talent sourcing assistance, and mentorship to founders.
2. Private Debt
Private debt refers to investments that are not financed by banks (i.e., a bank loan) or traded on an open market. The “private” part of the term is important—it refers to the investment instrument itself, rather than the borrower of the debt, as both public and private companies can borrow via private debt.
Private debt is leveraged when companies need additional capital to grow their businesses. The companies that issue the capital are called private debt funds, and they typically make money in two ways: through interest payments and the repayment of the initial loan.
3. Hedge Funds
Hedge funds are investment funds that trade relatively liquid assets and employ various investing strategies with the goal of earning a high return on their investment. Hedge fund managers can specialize in a variety of skills to execute their strategies, such as long-short equity, market neutral, volatility arbitrage, and quantitative strategies.
Hedge funds are exclusive, available only to institutional investors, such as endowments, pension funds, and mutual funds, and high-net-worth individuals.
4. Real Estate
There are many types of real assets. For example, land, timberland, and farmland are all real assets, as is intellectual property like artwork. But real estate is the most common type and the world’s biggest asset class.
In addition to its size, real estate is an interesting category because it has characteristics similar to bonds—because property owners receive current cash flow from tenants paying rent—and equity, because the goal is to increase the long-term value of the asset, which is called capital appreciation.
As with other real assets, valuation is a challenge in real estate investing. Real estate valuation methods include income capitalization, discounted cash flow, and sales comparable, with each having both benefits and shortcomings. To become a successful real estate investor, it’s crucial to develop strong valuation skills and understand when and how to use various methods.
5. Commodities
Commodities are also real assets and mostly natural resources, such as agricultural products, oil, natural gas, and precious and industrial metals. Commodities are considered a hedge against inflation, as they're not sensitive to public equity markets. Additionally, the value of commodities rises and falls with supply and demand—higher demand for commodities results in higher prices and, therefore, investor profit.
Commodities are hardly new to the investing scene and have been traded for thousands of years. Amsterdam, Netherlands, and Osaka, Japan may lay claim to the title of the earliest formal commodities exchange, in the 16th and 17th centuries, respectively. In the mid-19th century, the Chicago Board of Trade started commodity futures trading.
6. Collectibles
Collectibles include a wide range of items such as:
- Rare wines
- Vintage cars
- Fine art
- Mint-condition toys
- Stamps
- Coins
- Baseball cards
Investing in collectibles means purchasing and maintaining physical items with the hope the value of the assets will appreciate over time.
These investments may sound more fun and interesting than other types, but can be risky due to the high costs of acquisition, a lack of dividends or other income until they're sold, and potential destruction of the assets if not stored or cared for properly. The key skill required in collectibles investment is experience; you have to be a true expert to expect any return on your investment.
7. Structured Products
Structured products usually involve fixed income markets—those that pay investors dividend payments like government or corporate bonds—and derivatives, or securities whose value comes from an underlying asset or group of assets like stocks, bonds, or market indices. Examples of structured products include credit default swaps (CDS) and collateralized debt obligations (CDO).
Structured products can be complex and sometimes risky investment products, but offer investors a customized product mix to meet their individual needs. They're most commonly created by investment banks and offered to hedge funds, organizations, or retail investors.
Structured products are relatively new to the investing landscape, but you’ve probably heard of them due to the 2007–2008 financial crisis. Structured products like CDO and mortgage-backed securities (MBS) became popular as the housing market boomed before the crisis. When housing prices declined, those who had invested in these products suffered extreme losses.
Related: Financial Terminology: 20 Financial Terms to Know
Deciding to Pursue a Career in Alternative Investments
If you’re interested in pursuing a career path that includes alternative investments, it’s important to consider your professional goals and which asset classes are most interesting to you. Perhaps you want to fund tech start-ups and get involved in venture capital, or maybe you’re more interested in tangible assets and want to break into the real estate business. Alternatives offer a variety of liquidity, industry, and time horizon options.
The Benefits of Alternative Investments
Alternative investments offer greater portfolio diversification and lower overall risk with the potential for higher returns. As alternative investments become a larger part of the investing landscape and more available to different types of investors, they're increasingly important to know about for both investors and current or aspiring investment professionals hoping to accelerate their careers.
Do you want to join one of the fastest-growing fields in finance? Explore our five-week online course Alternative Investments, and learn how you can develop the confidence and skills to assess potential investment opportunities and maximize the value of your portfolio.
This post was updated on April 14, 2022. It was originally published on May 7, 2020.
