Alternative assets can provide investors with distinct opportunities to diversify traditional investment portfolios. Their performance tends to be uncorrelated to public market assets like stocks and bonds, offering investors the potential for increased returns and limiting volatility risk mitigating risk of exposure during public market drawdowns. It is also important to note that they are less liquid than public markets, which could make them harder to sell.
Assessing alternative asset opportunities requires a comprehensive, careful approach to help ensure that an investment aligns with your unique financial goals, desired outcomes, and risk tolerance.
Here are five best practices that Alto advocates investors keep in mind when evaluating potential investments in alternative assets.
What are alternative assets?
First things first, it’s important to understand what alternative assets are. Alternative assets are investments that fall outside the traditional categories of stocks, bonds, and treasury notes. They can include everything from startups to real estate and private equity, infrastructure projects, and even tangible assets like fine art and wine and rare collectibles.
Unlike historically conventional investments, alternative assets may provide noteworthy risk-return profiles. They offer diversification benefit potential due to their low correlation with public markets and can serve as a hedge against public market volatility. Some alternative assets may also allow investors to capitalize on economic trends or opportunities that wouldn’t otherwise be available through traditional investment vehicles.
Five best practices for assessing an opportunity
Understanding the characteristics, benefits, and potential pitfalls of alternative assets is important. Before adding alternatives to your portfolio, consider these best practices to help ensure a well-diversified and smart investment strategy.
1. Do your due diligence
Always do your research on the asset you want to include in your investment portfolio. You should understand the nature of the alternative asset, its market, and its historical performance. This may include studying market trends and demand drivers and examining any potential risks.
For example, if you are looking into investing in fine wine, research the types of wine you want to invest in. Look into trends within the fine wine industry across regions and vintages, and understand the history of the demand for the specific types of wine that interest you most.
2. Evaluate the potential risks and returns
Identify specific risks associated with the asset, such as market risks and liquidity challenges. For some alternative assets, operational risks may also be worth exploring. Evaluate how these risks compare to the risks of traditional assets you may already have in your investment portfolio. (For example, if you’re investing in fine wine, consider any climate concerns or supply chain issues that may increase the risks of your investment.)
Also, analyze expected returns, considering both income generation and capital appreciation. Monitor broader economic indicators and market conditions that could affect the performance of the alternative asset(s) you choose. This includes interest rates, inflation, and geopolitical events that could swing your investments either way.
3. Understand the liquidity
Liquidity is a key consideration when assessing alternative asset opportunities because it directly affects your ability to access your funds and respond to market changes. This is especially important if you have short-term goals and may need liquid cash for a major purchase in the near future. If your money is tied up in an illiquid asset, it can pose challenges for you. So be sure to assess how easily the asset can be bought or sold in the market.
Most traditional or public securities are liquid assets that can be quickly sold or converted to cash with limited impact on price, providing you with more flexibility to take advantage of new investment opportunities or manage major (and even unforeseen) expenses. On the other hand, illiquid assets cannot be easily sold or may require significant time and effort to convert to cash.
4. Consider diversification scenarios
Evaluate how the alternative asset fits into your overall portfolio and whether or not it’s correlated with other assets you already invest in. While most alternatives are uncorrelated to traditional assets, it’s worth looking into how a new alternative asset will fit into the diversification profile offered by its interaction with your other alts, too. Understanding and intentionally designing your diversification strategy is key, because it is the part of modern portfolio theory that disperses risk, which may better protect your portfolio in the event of public market downturns.
A diversified portfolio may better withstand market volatility and economic fluctuations.
5. Analyze fees and tax implications
Examine all fees associated with the alternative asset investment, including any management fees, performance fees, transaction costs, and any other costs of the investment. After all, even if the investment opportunity offers the potential for high returns, high fees can significantly cut into them.
You should also research tax implications. For example, real estate investments may entail property taxes, depreciation schedules affecting capital gains taxes upon sale, and potential deductions for mortgage interest. All of these factors can affect how much you actually earn from the investment. Similarly, cryptocurrencies, fine art, and rare collectibles can trigger capital gains taxes upon sale, and hedge funds can carry hefty performance fees subject to ordinary income tax rates.
Understanding these nuances is critical to optimize your after-tax returns.
The bottom line
The world of alternative assets is growing fast, and there’s a lot to learn for prospective individuals seeking to access these new, high risk, yet interesting investment opportunities. While education and awareness of one’s unique financial situation is every investor’s sole responsibility, working with financial professionals to explore alternatives and private market opportunities can offer significant advantages.
Alto, for example, provides access to a wide range of alternative assets and curated private market opportunities, along with education and stellar customer service and support for investors.
Alto lets individual investors use their IRAs to diversify their portfolio beyond the public markets with non-traditional assets.
Open an Alto IRA to discover the many ways Alto enables you to diversify your portfolio.
