What Can Alternative Investments Bring to Your Portfolio?
What’s all the fuss behind alternative investments? Why use alternative investments? Here’s why investors are branching out of the stock market to strengthen their portfolios.
When you picture investing, you probably picture Wall Street—which is to say, you picture stocks.
To be fair, most Americans rely on stocks for investment. As of 2021, 56% of Americans reported owning stocks, primarily through their retirement accounts.
But there’s a whole wide world of investments out there. In fact, alternative investments are increasingly popular. According to Preqin, the alternative investment market will hit $14 trillion by 2023. Why use alternative investments, and what can they do for your portfolio? Here’s what investors need to know.
What are Alternative Investments?
Alternative investments are simply any form of investment that doesn’t fall into one of the three conventional investment categories:
This means that alternative investments are an incredibly broad group of assets. The category includes things like:
- Fine art
- Hedge funds
- Real estate
- Private equity
- Private debt
- Distressed securities
- Venture capital
- Peer-to-peer lending
Traditionally, these investments were the playground of institutional investors and the wealthy. These days, though, alternative investments are becoming increasingly open to ordinary investors.
How They Differ from Conventional Assets
Comparing a Van Gogh and venture capital might seem like comparing a raven and a writing desk, but alternative assets actually have a few key features in common.
First, alternative investments have a higher purchase price and higher initial transaction fees. This is part of why alternative investments were traditionally open to high-net-worth individuals only—alternative assets require a greater degree of financial sophistication to understand what you’re getting into, or at least, enough capital to weather losses.
Second, alternative investments are fairly illiquid, especially in comparison to conventional investments. There are a few reasons for this. For one, the market is much smaller—you’ll have a much easier time finding buyers for Apple stock than buyers for Magritte’s Son of Man. For another, many alternative investments are difficult to value, since they don’t publish verifiable performance data very often and may not have a point of comparison. Just look at art, where market-moving information used to set prices is routinely used to turn a profit and one-of-a-kind artwork is set by consensus valuation.
Third, as you can likely guess, alternative assets are far more complex than conventional assets. You know what you’re getting into with a stock. It’s easy to buy and sell. But a Zeng Fangzhi painting, for example, is a whole different story. Never mind hedge funds or private debt.
Why Use Alternative Investments?
In simple terms, alternative investments come with unique complications that you don’t see in conventional assets. So why would you use alternative investments in your portfolio?
While alternative investments come with unique risks because of their inherent qualities, they also come with a unique set of benefits because of those same qualities.
Low Stock Market Correlation
The number one reason most investors turn to alternative investments is diversification. The nice thing about alternative investments is that they provide diversification in a unique way because they have little or no correlation to the stock market.
Remember, alternative investments don’t derive value from the stock market (at least, most of them don’t). They derive value from their own inherent qualities, and these have little to do with the stock market.
This does not mean that alternative investments don’t move in response to the stock market, nor does it mean that alternative investments are less volatile than the stock market (most are not, but some are). It depends on the investment in question, which is why it pays to do your homework. However, because alternative investments have low stock market correlation, they can be useful to insulate your portfolio against stock market volatility.
Another popular reason investors turn to alternative investments is inflation hedging, which is when you make an investment to protect against the future decline in purchasing power of a given currency.
For example, many wealthy art investors have long turned to fine art as an inflation hedge. Blue-chip art retains its value because of its inherent qualities, which means you can generally count on it to be worth just as much regardless of the purchasing power of a given currency.
This is not guaranteed—no investment can guarantee that it will outperform inflation, or even guarantee that it will generate returns. However, smart alternative investments can certainly pay off this way.
Passive Income (in Some Cases)
Finally, in some cases (not all), alternative investments may allow you to generate passive income.
This isn’t necessarily unique to alternative investments, but the passive income you can generate looks different from what you would see on bonds, for example. The best example is real estate investing where you earn income by collecting rent.
Ready to Use Alternative Investments in Your Portfolio?
Why use alternative investments? In short, because they make your portfolio stronger.
And here at Masterworks, we’re here to make one of the best forms of alternative investment (blue-chip art investing) accessible to everyday investors like you. On our platform, you can purchase shares in authenticated multi-million-dollar art for as little as $20 per share, and when we make the sale, you earn dividends. Ready to put alternative assets to work? Fill out your membership application today to learn what blue-chip art can do for your portfolio.