Why Use Alternative Investments in a Portfolio?

A classic car car can be a fun alternative investment, but it is a risky one.

A classic car car can be a fun alternative investment, but it is a risky one.

When learning about wise investing, you'll hear a lot of talk about diversification. Keeping a variety of different assets in your portfolio balances your holdings and should help protect you in case one type of investment loses money while another remains stable or gains. Alternative investments are non-traditional ways to broaden your portfolio, and they might make you money when traditional investments are losing ground.

Economic Downturns

Traditional stocks and bonds have bull and bear markets. Real estate has its downturns, too. The 2008 bear market dropped in tandem with the bursting of the housing bubble, so few investors were safe in the subsequent recession. During this same time, however, some players in alternative investments managed to post healthy returns. Take the example of Harvard University's savvy endowment investors, who posted an 8.6 percent return for the year through alternative investments.

Beyond Stocks and Bonds

Commodities and foreign exchange markets are examples of alternative investments. They can be difficult to understand, but often have good returns when other markets are performing poorly. Gold reached all-time highs in 2010, when nervous investors flocked to invest in the old favorite as well as other precious metals. Foreign currency traders profit from daily fluctuation in the values of different global currencies. Wine, classic cars and art can be lucrative alternative investments but are vulnerable to the whims of collectors. They can be difficult to unload and are probably best left to investors who are collectors themselves so that you can at least drown your sorrows in your bottles of wine or take a ride in your vintage automobile if their financial value declines. Do not jump into any alternative investment unless you understand its underlying risks.

Other Alternatives

Other popular alternative investments are hedge funds, private equity and real estate. Hedge funds are are seen as good alternatives because of their professional management, lower minimum investments and diversified assets, even though they are tightly regulated. They have often done well when traditional markets performed poorly. Private equity, like venture capital, lets you invest in up-and-coming companies that are not yet public. It can produce amazing returns, but your money might be tied up for years and could be lost completely. If you own your home, you are already a real estate investor. Traditional income property ownership requires hands-on management, but you can still participate in real estate through alternative investments like real estate investment trusts (REITs). Real estate sometimes returns well when other investments do not.

Keeping Liquid Assets

Everyone understands cash, and it is a type alternative investment as well. A large cash cushion means you won't get good returns on your money in times when interest rates are low, but it is also not vulnerable to market ups and downs. Keeping liquid assets gives you an emergency fund. Cash also means that you have funds available to take advantage of buying opportunities for traditional or alternative investments during down markets.

About the Author

Annabella Gualdoni has written newsletters and reports for corporations and nonprofits since 1994. She is a real estate professional and also teaches subjects including international cooking and travel, dating/relationships and personal finance. Gualdoni has a Bachelor of Arts in international development from University of California, Berkeley, a Master of Arts in international relations from Boston University, and a Juris Doctor from Boston College Law School.

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