In a financial landscape dominated by stocks and bonds, many are looking beyond the norm and exploring alternative investments. As the winds of the economy shift, it’s critical to find options that may stand strong, even through potential recessions. But are alternative investments the right choice for you? Let’s find out!
What Is an Alternative Investment?
Simply put, an alternative investment is any financial asset that doesn’t fall into the traditional categories of stocks, bonds, or cash. These investments could include art, rare coins, private equity, life settlements, and much more.
It’s important to consult your financial advisor for advice whenever you are considering any investment moves to assess whether such investments are suitable for you based on your investment goals, risk tolerance, and financial situation.
What Are the Disadvantages of Alternative Investments?
There’s a certain allure in finding unique ways to invest money. However, these alternative routes also come with their set of challenges, such as:
- Complexity: Some alternative investments are not as straightforward as buying stocks or real estate. Consider hedge funds, for example. They employ diverse strategies such as long-short equities, global macro, and event-driven, each with its set of risks and benefits. For an average investor, understanding the nuances can be overwhelming. In 2008, many investors in hedge funds found it challenging to interpret their positions, especially during the financial crisis.
- Liquidation Challenges: Converting alternative investments into cash isn’t always a smooth or simple process. Art is a classic case. Imagine you’ve acquired a masterpiece by a renowned artist, expecting its value to appreciate. However, when you decide to sell, the market may be down, or finding a buyer willing to pay your asking price could become a lengthy process.
- Higher Fees: Venturing into the less-trodden path of alternative investments can be expensive. Private equity funds, which invest directly in private companies, are known for their fee structures. Typically, they charge a 2% management fee and a 20% performance fee. This is significantly higher than the fees of a traditional mutual fund, which averages around 0.5% to 1% annually.
- Regulation: Most alternative investments are unregulated, which can lead to potential fraud or scams. Bernie Madoff’s Ponzi scheme is a prime illustration. Posing as a hedge fund manager in the mid-2000s, Madoff defrauded thousands of investors of billions of dollars. Due to the less stringent regulations around such investments, he was able to dupe investors for years. Thankfully, after high-profile frauds like this, global regulators have tightened rules and boosted transparency for alternative investments to better safeguard investors. However, there are certainly still risks as alternative investments are largely unregulated.
What Are the Advantages of Alternative Investments?
The main advantage of alternative investments is simple: diversification. By adding alternative investments to your portfolio, you’re avoiding putting all your eggs in one basket, which can potentially help cushion against losses in any one area. Other advantages include:
- Less Volatility: Some alternatives can offer steadier returns, especially useful for those thinking, “I don’t want to invest in the stock market.” For example, life settlements can be an excellent alternative investment option. They involve purchasing a life insurance policy at a discount from the policyholder and receiving the death benefit payout, which is typically higher than the purchase price and always higher than the cash surrender value. Since life settlements are largely independent of market fluctuations, they tend to be more stable, providing a potential safeguard during turbulent financial climates.
- Potential for High Returns: Certain alternatives may offer higher potential returns than traditional investments. A great example is venture capital investments in startups, which can yield substantial returns if the startup succeeds. According to Investopedia venture capital led the performance charts with an average annual return of 15.15% between 2010 and 2020. In comparison, the S&P 500 trailed with annual returns of 13.99% during the same period.
- Unique Opportunities: Investing in alternatives gives you a chance to invest in something you’re passionate about—be it art, wine, or startups. To illustrate, the investment in classic cars has caught the attention of many aficionados. The HAGI Top Index, which monitors vintage collectible vehicles from brands like Porsche, Ferrari, Bugatti, and Alfa Romeo, paints an intriguing picture. Investopedia reports that this index soared by 33.78% in 2019. And despite challenges from the pandemic, it grew by 6.19% in 2020 and further climbed 2.73% in 2021 year-over-year.
- Hedge Against Inflation: As prices rise, some investments may help protect against inflation. For instance, real estate is traditionally viewed as a safeguard against inflation. As living costs go up, so too can rent prices and property values. Additionally, gold has historically been viewed as an inflation hedge. In periods of high inflation, such as the late 1970s, the price of gold surged, helping investors retain the value of their money.
It’s important to note that 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.
Not Sure Where to Put Money Now? Give Life Settlements a Try
Life settlements are a fascinating alternative investment avenue that many aren’t familiar with. Here’s a brief overview:
- From the policyholder’s perspective: A life settlement is the process of selling a current life insurance policy to a third party for an amount that is a higher number than its surrender value but lower than its overall death payout. This investment can be a way for the policyholder to get more value from a policy they no longer want or need. To qualify, you must be 65 years or older, have had your policy for at least two years, and have a death benefit of at least $100,000. Check out this qualification calculator to see if you qualify.
- From the investor’s perspective: An investor buys the policy, continues paying the premiums, and receives the death benefit when the insured person passes away. It’s a unique way to invest, offering potential returns that aren’t tied to stock market performance.
Curious to learn more about this alternative investment, especially in uncertain times? Reach out to us at i2 Advisors for assistance in navigating this intriguing investment option.
THIS MATERIAL IS FOR EDUCATIONAL AND INFORMATIONAL PURPOSES ONLY. OTHER THAN LIFE SETTLEMENTS, I2 ADVISORS DOES NOT PROVIDE THE SERVICES DESCRIBED IN THESE EDUCATIONAL MATERIALS NOR DOES IT RECOMMEND ANYONE TO INVEST IN THE ASSETS DESCRIBED THEREIN. ALL INVESTMENTS CARRY RISK AND INDIVIDUALS SHOULD CONSULT WITH THEIR FINANCIAL PROFESSIONALS BEFORE UNDERTAKING ANY TYPE OF INVESTMENT. THIS INFORMATION DOES NOT CONSTITUTE INVESTMENT ADVICE AND SHOULD NOT BE CONSTRUED AS A SOLICITATION OR OFFERING OF ANY INVESTMENTS DESCRIBED THEREIN.