7 Alternatives to Investing in the Stock Market
For generations, the stock market has been a useful tool for Americans to build and maintain wealth. Investing in stocks can preserve purchasing power in the face of inflation and provide substantial growth for those who invest early in their careers, but there are also stock market alternatives that can provide unique opportunities for diversification.
The 60/40 stock-bond portfolio has been the bedrock of many retirement plans for decades, but stocks and bonds aren’t the only asset classes where investors can park their money.
The internet has introduced many new forms of investing, from peer-to-peer lending to crowdfunding to cryptocurrencies. Investors no longer have to rely solely on stocks and bonds to preserve capital, but many of these new asset classes carry substantial risks.
It’s crucial to understand the pros and cons of any investment before diving in — here are seven alternatives to investing in stocks, along with the benefits and drawbacks of each market.
The forex market is the largest public market on the planet. Forex is short for ‘foreign exchange’ and involves buying and selling currencies.
Forex trades are made in pairs, with one short position and one long position. For example, a USD/CAD would open a long position in the US dollar and a short position in the Canadian dollar. If CAD declines in relation to USD, the trade will make money. If the value of USD declines against CAD, the trade will lose money. Forex markets are open 24 hours a day from Sunday evening to Friday evening.
Leverage often fuels forex trades, so new traders must understand the potential pitfalls of trading with borrowed money. When using leverage, margin maintenance levels must be held.
For example, if you’re trading with 2-to-1 leverage, you can open a $10,000 position with only $5,000 and borrow the remaining $5,000. However, if the value of your investment drops 50%, you’ll be left with nothing as you’ll need to use your initial $5,000 investment to pay for your margin loan. Leverage can boost profits but also exacerbate losses.
Digital currencies like Bitcoin (BTC) and Ethereum (ETH) are among the newer assets reaching the public.
In theory, cryptocurrencies allow buyers and sellers to complete transactions using digital tokens without needing a centralized authority to confirm the transaction. Instead, digital currencies use a blockchain public ledger to verify transactions and prevent tokens from being ‘double-spent.’
Cryptocurrencies have become popular for speculation since their volatility can create huge gains on the long and short sides. Non-fungible tokens (NFTs), decentralized lending (DeFi), and perpetual futures trading are some ways investors have used cryptocurrencies.
However, volatile assets like cryptocurrencies can be dangerous if misused, especially in the futures market where forced liquidations are common. The volatility of crypto might not be something investors with a limited risk appetite can stomach.
What’s a forced liquidation? In the cryptocurrency futures market, trading is done with perpetual contracts. At the end of each day, these contracts payout based on which side profits (long or short). The position will be automatically liquidated if a cryptocurrency investor is on the losing side of a trade and doesn’t have the capital to meet margin requirements.
3. Real Estate
Home purchases are often the most significant investment people make in their lives. Not only does a house tend to appreciate over time, but borrowing costs for a home are cheaper than most alternatives, and owners can borrow against the equity in their homes. Plus, primary residence sales have tax breaks, such as no capital gains taxes on the first $250,000 of profit ($500,000 if married) from selling a primary home.
Apps like Airbnb have also made it easier for rental properties to flourish. By renting out a second property to tenants, owners have their mortgage paid by the renters while benefiting from the appreciation of the home or building.
Buying property isn’t the only way to invest in real estate. For example, Real Estate Investment Trusts (REITs) are publicly-traded securities sold on exchanges to provide exposure to various sections of the real estate market, such as commercial properties, single-family units, and multi-family apartment buildings.
Another option is real estate crowdfunding, which bypasses the public markets, allowing investors to put money directly into specific properties and locations that fit their time horizon and risk tolerance.
Real estate investing carries its own set of risks as well. Property is highly illiquid. To sell a home or building, investors must find a willing buyer (which can take time) and pay a litany of fees.
Property also requires maintenance, which can be expensive if a significant appliance needs replacing. Unlike a stock or futures contract, selling a home won’t be completed in a day.
Commodities are expected to be an asset class of interest over the next few years as supply chains untangle themselves in the wake of the COVID-19 pandemic. Commodities are essential goods used in various services and industries, usually consisting of raw materials or agricultural products.
Some of the more popular commodity trading markets include energy (oil, gasoline), metals (silver, copper, gold), and agriculture (coffee, milk, hogs, soybeans).
How does an investor buy and sell raw materials like crude oil or coffee grounds? They do it not through buying and selling the materials themselves, but through futures contracts that act as derivatives on the underlying asset.
For example, if an investor thought the price of oil would rise to $120 by September of 2022, they could purchase a contract from the NYMEX West Texas Intermediate (WTI) crude oil future market on an exchange such as CME Group. If oil surpasses the $120 mark by September, the $120 WTI Crude Sept 22 futures contract can be sold for a profit. Many companies like oil drillers use futures contracts to lock in their ideal price and combat the volatility of commodities markets.
Additionally, ETFs and mutual funds based on the underlying asset provide exposure to various commodities. For example, the SDPR Gold ETF (NYSE: GLD) owns physical gold and allows investors to profit from a rise in gold prices without needing to possess gold itself.
Commodities can be a terrific trading asset but often suffer as a long-term investment. Economic and geopolitical issues often greatly influence products like oil or wheat, resulting in volatile price movements.
Digital collectibles like NFTs made plenty of headlines last year, but collectibles are hardly a new investment class. Surely everyone remembers Beanie Babies, right? But collectibles can be a highly lucrative asset class for investors, especially considering the diverse number of industries they circulate through.
Collectibles that can be bought and sold for profit include baseball cards, stamps, wine, antiques, or rare memorabilia. These items are more liquid than properties like houses since they can be sold online, in person, or at various trade shows — but there is a major tax drawback to investing in this asset class.
Collectibles aren’t taxed at the capital gains rate (0%, 15%, or 20%, depending on income). Instead, collectibles are taxed at a flat 28% rate, making them less tax-efficient to hold long-term versus other assets like stocks, cryptocurrencies, or real estate, which get the preferable capital gains rate.
Like other collectibles, fine art is traditionally a tangible asset, something physical that is kept in one’s home. While blue-chip art by well regarded fine artists are the most traditional way to invest in art, that once-exclusive market is rapidly being exposed to a new investing class.
Sites like Masterworks allow individual people to invest in shares of iconic artwork. Masterworks purchases the work, enables clients to invest in shares, and they can earn a profit on any price appreciation. Art markets are often illiquid, but this makes buying and selling art easier by creating a secondary market.
Liquidity concerns aside, art suffers from the same tax rate as collectibles: a flat 28% on profit. Therefore, consider your tax burden when investing in alternative asset classes like art and collectibles.
Crowdfunding isn’t its own asset class, but a method of funding specific projects through public investments. Think of it as venture capital for small accounts.
Investing in early startups can potentially result in exponential gains, but this comes with risk. Many new businesses flop, and crowdfunding projects sometimes fail to provide returns. Additionally, many of the most popular crowdfunding websites and projects don’t offer equity for contributions, so be on the lookout for equity crowdfunding opportunities.
When using crowdfunding as a source of investment income, be sure to spread capital across a variety of different projects, so the failure of one doesn’t sink your entire portfolio.
This content is provided for informational and educational purposes only. It is not intended to be investment advice nor should it form the basis of an investment decision. See important Regulation A disclosures at masterworks.io/cd