Inflation is already at a four decade high, and the Federal Reserve warns that rising gas prices due to the Ukrainian invasion may push it even higher, faster than most Americans can keep up.
Individual investors have traditionally put money into stocks, bonds, or buy and hold rentals. However, many are now shifting strategies toward other investment areas with the hope of diversification and higher returns.
Despite the investment risk that alternative investments present, institutional investors, pension funds, and accredited investors have dabbled in them for decades. With inflation climbing and stock market volatility on the rise, will alternative investments benefit individual investors?
6 Alternative Investments Growing in Popularity
Cryptocurrency is arguably one of the most popular alternative investments available today, with trillions invested in various currencies. They are highly volatile – for example, Bitcoin, the most well-known crypto at the moment, has lost more than 40% of its value from its high a few months ago.
Unlike other traditional investments, cryptocurrencies are not backed by tangible assets. It means that market sentiment determines its worth. A quick change in feelings about a currency, or a tweet from the right person, can send the price of crypto into a tailspin.
With the growing popularity of crypto, the SEC approved the first futures-based ETF that tracks bitcoin in 2021. Individual investors now have the option to invest in a cryptocurrency IRA.
Commodities are physical things and they take many forms, including:
- Hard commodities. These are typically mined items and include precious metals like gold, silver, palladium, and lithium, or oil. These are among the oldest and most commonly used commodities.
- Soft commodities. These are typically grown or herded and include agricultural products like wheat, soy, or oranges. They also comprise living products, like cattle.
Hard and soft commodities have been around for centuries and are used extensively by individuals or have a long-term place in various economies, so they are likely to stay in demand. Investors will frequently buy gold or silver in times of trouble as it is considered extremely low-risk.
Besides directly buying gold or silver, it is harder to invest in other commodities. One could own shares of mining companies that drill for lithium, nickel, and cobalt, which are projected to be in higher demand with the rise of electric vehicles and batteries.
Investing in agricultural land was always problematic due to the regulations, the enormous cost of owning farmland, and the lack of local knowledge. However, with the advent of crowdfunding, that has begun to change, as we’ll discuss in a moment.
#3 Art or Collectibles
Investments in art and collectibles have become more popular as of late. This includes purchases of valuable furniture, paintings, baseball cards, and more.
There are many challenges when it comes to investing in collectibles. For one thing, it can be impossible to predict when a collectible will rise in value. A baseball card or collection expected to skyrocket in value may turn out to be a dud, losing the investor money.
Collectibles must be authenticated, and fraud is a concern. Importantly, they have little intrinsic value – the value must be agreed upon by the purchaser, seller, and collectible community at large.
Crowdfunding has eliminated the barriers of high cost and lack of access to art investment.
#4 Hedge Funds
Hedge funds involve investors pooling their money and hiring an outside financial manager to manage their investments and grow their wealth.
A hedge fund will not just make stock or equity purchases but will invest money in an array of sources that is typically inaccessible to “regular” investors, including derivatives or private debt.
It is essential to be aware that hedge fund investments may be less liquid, use leverage, have less transparency, and charge higher fees, including a performance incentive.
The track record of success for hedge funds that permit external capital is hard to track.
#5 Venture Capital
Venture capital is a particular type of private equity. Like hedge funds, it tends to be closed off to the public at large. Venture capital funds will invest in startups and are often associated with technology companies.
They will thus provide seed money to help get a company started, often providing critical funding at a time when a product or service is just being rolled out to the public. A fund will acquire a stake in the company to sell later for a healthy profit.
This type of fund capital can be hazardous. Furthermore, there is never any guarantee of success for the investment fund.
You must have read that early investors in Google or Facebook became very wealthy by investing in VC rounds, but a large number of startups fail. Hence, one needs to be knowledgeable enough about the startup and have deep pockets to participate in seed funding to Series D.
#6 Real Estate Crowdfunding
The passage of the JOBS Act opens the door to use real estate crowdfunding to purchase residential, commercial, or agricultural land which was inaccessible to investors earlier.
Like any other form of crowdfunding, various investors essentially pool their money and use it to purchase real estate. A professional or a real estate firm manages the capital and the property.
Real estate crowdfunding allows people to make large purchases in real estate that they would not be able to otherwise. However, it also comes with a loss of some control over the asset.
Risks of Alternative Investments
All of the above methods of investment hold a great deal of potential. However, there are huge risks involved with all of the above methods. Consider the following:
Lack of Regulation
Perhaps the greatest danger of any alternative investment lies in the absence of regulation. Many investors believe a lack of code to be a good thing, as they feel that overregulated markets limit growth. However, with many alternative investments, this can be a real danger.
A lack of regulation manifests in many forms, including gaps in transparency, unlicensed and unscrupulous vendors, and outright inaccurate or fraudulent information.
One of the characteristics of many alternative markets is that they are often highly volatile. This unpredictability is often seen in rapid swings over brief periods. While some traders have the resources or timeframe to absorb this instability, individual investors might not have this luxury.
The old axiom, “Past performance doesn’t guarantee future success” remains true. However, it doesn’t change the fact that past performance is often the only thing that investors have to judge a market investment. As such, they rely on history to make informed choices.
With alternative investments, this can be a considerable challenge. Many alternative investments are brand new. Without a track record, it can be difficult – or impossible – to judge how successful an investment will be.
Failure to Appreciate as Hoped
Another challenge is that many alternative investments don’t appreciate. This is regularly the case with collectibles. Many purchase collectibles with the belief that its value will increase over time, but there is no guarantee that this will true.
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