Personal Finance For Young Adults: Alternative Assets—Everything But The Kitchen Sink
Do you already understand the basics of stocks and bonds, mutual funds, and asset allocation? And are you ready to dive deeper and learn about alternative assets—what they are, how they might fit into your portfolio, and why they may or may not be appropriate for you?
Many investors often think of investments as being limited to just stocks and bonds. And while these traditional assets tend to make up the majority of the open market, there is an entire universe of other assets that represent a very different side of investing: alternative assets.
What is an alternative asset?
There’s a lot of mystery surrounding alternative assets. This is most likely because alternative assets are not any one thing in particular. Instead, it is a broad term that encompasses any nontraditional asset or investment strategy that can’t be categorized as a stock, bond, cash, mutual fund or exchange-traded fund.
Alternative assets are becoming more popular, and while they offer a number of advantages for investors, they may not be right for everyone. Alternative assets are typically illiquid, meaning they can’t easily be sold or converted into cash. They often have high minimum investments and fee structures, and many have less oversight than stocks and bonds.
Some examples of alternative assets
Private equity is a form of capital investment in a private company. Typically, private equity firms raise funds from noninstitutional and institutional investors to buy a business with the goal of selling it later to make a profit.
Private equity can provide funding for early stage companies, or as a financing vehicle for mature companies to facilitate growth. Private equity can also buy out another company or division.
With private equity, your investment in a company will grow as long as the business grows. However, the returns you get from private equity depend on the performance of the company, and there’s no guarantee that a company will grow. Private equity investments may offer higher returns, but they, generally, also involve higher risk. In addition, private equity has a long investment phase, which means it could be awhile until you get your money back.
A hedge fund is a pooled investment structure similar to a mutual fund that uses different strategies to generate an active return on an investment. Hedge funds are typically for high net worth individuals and institutional investors, and they operate with much less regulatory oversight by the U.S. Securities and Exchange Commission (SEC).
Hedge funds include a variety of trading strategies that seek out market inefficiencies. This means hedge fund managers have the potential to add significant value to their investments over time.
Real assets are tangible assets that have intrinsic value, such as precious metals, oil and other commodities. Luxury items and collectibles such as art and vintage cars also fall into this category.
The value of real assets often relates directly to supply and demand: The higher the demand for a scarce asset, the greater its value is in the market. However, because there are numerous factors that can dictate the rise or fall in the value of specific assets, detailed knowledge of each asset is essential when trying to gauge price movements. Additionally, most tangible assets are illiquid, making it harder to cash them in.
Real estate typically is considered an alternative asset when the property is not your primary home but is used for investment, such as an office building or rental unit.
Why invest in alternative assets?
Alternative assets are often best used as a complement to your traditional portfolio rather than as a replacement.
One of the main reasons people use alternative assets is for diversification. This could be important for investors hoping to achieve their long-term financial goals while minimizing risk. When you add alternative investments to a portfolio, you’re adding an asset class or investment strategy that tends to behave differently than stocks and bonds.
Alternative assets can also boost portfolio returns. While alternative assets are more complex and often have high-risk profiles, they can also generate higher returns than traditional investments by providing exposure to unique return streams and return opportunities that you would not get exposure to with ordinary stocks and bonds.
Alternative assets typically have a low correlation with stocks and bonds. Because various asset classes react and behave differently in different parts of the market cycle, alternative assets can be used to help diversify a portfolio to achieve less volatile returns, particularly during uncertain markets.
Income potential is another reason why investors invest in alternative assets. Some alternative assets may offer higher yields than traditional investments—especially during periods of low interest rates.
Alternative assets are more complex than traditional investments, which makes understanding these investments even more important. If you are considering investing in alternative assets, we recommend getting advice from your investment advisor to determine if they are right for you.
CIBC Private Wealth’s Wealth Your Way podcast series is an educational offering for clients and their children, and demonstrates our commitment to developing the rising generation. Listen to the podcast on alternative assets here. There, you will also find other informative podcasts that are designed to help rising professionals steer through their personal financial journeys.