At the risk of sounding basic, we’re going to go ahead and restate an investing 101 bedrock principle: Diversify your portfolio. Those early in their investment journey might take that to mean buying stocks from a few different companies whose operations are uncorrelated. 

But that would amount to a basket with some different colored eggs in it – all still bound to the fate of the basket. 

Though the stock market is indisputably the greatest wealth generation machine of all time, the rise of algorithmic trading has tangled the performance of individual companies to the market at large.

That’s why investors are looking to diversify their portfolio not only within the stock markets, but in alternative investments.

What are alternative investments?

It’s easier to characterize alternative investments by what they are not. They are not cash, public stocks, and bonds. Consequently, they are generally characterized as less liquid and long term strategies.

On the upside, they open numerous avenues and opportunities ranging from safe investments with steady yield to high risk-investments with potentially quit-your-job returns. But where to start?

“I’d really break [alternate investments] down to four main sub equity classes, so: private equity, private real estate, private credit, and hedge funds,” says Kristin Olson, the global head of Alternative Capital Markets Group for Goldman Sachs.

“Last year, 2019, was frankly a record year for us in terms of capital commitment to alternatives for our clients.”

The great migration

There are several warning signs flashing that the stock market is in risky territory – from the concentration of investment in FAANG stocks making the market wobbly and top heavy, to runaway valuations that even healthy growth and scale would fail to justify.

While the stock market doesn’t always align with the books, the situation has made smart money just a tad uneasy. 

Smart money (i.e., the big dogs with deep pockets) have already been making moves into alternative investments to hedge against risk.

In fact, in October 2020, BlackRock – the world’s largest asset manager – advised investors to reorganize their portfolios from a 60-40 stock-to-bond ratio to incorporate alternative investments at 50/30/20 (stocks/bonds/alternatives).

Perhaps it’d be prudent to follow suit.

Types of Alternative Investments

Private equity investments

Barrier of entry: High

Risk factor: High

Potential returns: Max

Embrace your inner hipster: Find the next big thing before it goes mainstream. 

The sharks (you know, Mr. Wonderful, Mark Cuban, and so on) on Shark Tank are all making private equity offers and deals with the budding entrepreneurs presenting to them. 

That’s private equity investing 101. 

The key differentiation between private equity and publicly traded stocks is that stake in the company is not available to just anyone. 

And just like the sharks, private equity firms generally invest in startups, privately held companies, and companies in distress. 

They provide the capital the company needs, either to scale or overcome an obstacle, as well as ‘business management services’ (for better or for worse). 

At the end of the day, the goal of private equity investment is to generate value and return for investors – and a lot of it. 

The good news is, according to global capital management firm Bain & Company, private equity investments have generated a 60% higher return on investment compared to the S&P 500 over the last 30 years.

The bad news is that unless you spend your Wednesday afternoons on the golf course, private equity might be prohibitively expensive to get into. 

A $250,000 would be on the lower end of the entry price to go through an institution – and to be properly ‘accredited.’ But keep in mind: that buy in is still the coach class, boarding group C of private equity.

Hedge funds

Barrier of entry: High

Risk factor: Medium

Potential returns: High

Hedge funds are similar to private equity. They pool investors’ money and make strategic deals they’re betting will produce return. They’re also similar in that they require investors to be ‘accredited’ (read: a certified rich person).

Like private equity, a $250,000 minimum investment is par for the course and can run many times higher depending on the firm.

The key differentiator between hedge funds and private equity is the types of asset investments they make. 

Like private equity, hedge funds also buy stakes in private companies. But hedge funds investment strategies are more diversified. 

They also invest in public companies, real estate, and tangible commodities that appreciate like gold, fine art, wine, and collectibles (rumor has it the hedge fund manager who bet big on beanie babies in the ‘90s is no longer in the business). 

Big hedge fund managers are the celebrities of Wall St. – Ray Dalio, George Soros, and Bill Ackman. Those with the means to buy into their exclusive club can ride their coattails into the sunset. 

Warren Buffett, is not a hedge fund manager. What makes him different? Unlike hedge funds, the average investor can ride his coattails…by buying public shares in his company Berkshire Hathaway – no ‘accreditation’ required. No wonder he’s America’s favorite billionaire.

But if you can swing it and meet the accredited investor criteria, hedge funds tend to be pretty hands-off and safe investments.

Private real estate investment group

Barrier of entry: High

Risk factor: Low

Potential returns: Above average

Like private equity, the real estate market has also outperformed the stock market on returns for investors over the last few decades. 

However, unlike private equity, investing in real estate doesn’t have the same barriers of entry thanks to technology services and crowdfunding.

HappyNest, for example, allows investors to buy in for as low as $10. HappyNest and other private real estate investment groups buy, manage, and sell properties. By investing in HappyNest, the investor becomes a partial owner of these properties and their shares appreciate in tandem with the real estate’s value.

Real estate is widely considered to be a safe and reliable investment over time. Private real estate investment group investments are also insulated from stock market volatility since the aren’t caught up in EFT and other stock collectives.

Private credit: Peer-to-peer lending and crowdfunding

Barrier of entry: Low

Risk factor: Above average

Potential returns: Above average

Peer-to-peer lending cuts the middle man (i.e., the bank) out of lending. 

Through platforms like Lending Tree or Peerform, you can lend money (investment) to a person or a business. Then, you play banker and charge interest on repayment. 

The returns on private debt can be high – in the double digits. 

But for every yang, there’s a yin. High potential returns come with high potential risks.

Applicants’ risk profiles oftentimes do not meet the loan criteria for standard banks. That’s something the private lender (you) have to be willing to take on. If the borrower defaults, well, c’est la vie. 

That being said, peer-to-peer lending as an alternative investment strategy tends to perform better in economic downturns. That’s because banks become more risk averse and tighten their lending criteria. 

In a study released in August of this year by MarketWatch, the peer-to-peer industry was projected to grow by 30% – a sign that investors aren’t quite bearish on this alternative investment strategy just yet.

It’s also worth noting that the industry as a whole saw a high growth period after the Great Recession of 2008 as the credit markets recoiled.

That could mean that 2021 might shape up nicely for those with a bullish risk tolerance.

Alternative and foreign currencies

Barrier of entry: Low

Risk factor: Above average

Potential returns: Above average

The dollars’ value is only defined relative to foreign currencies. Since its March 2020 highs, the value of the dollar has lost 9% of its buying power  –  just eight months later.

That’s bad news for savers – and the catalyst for investors scrambling to find stable, alternative currencies, especially trillions of freshly printed dollars begin circulating.

Little problem though: The entire global economy is in a state of flux. It’s hard to tell which country’s economy (and by extension, currency) will stabilize first. 

Some countries’ look poised for a quicker economic recovery than others. Their currencies could gain value against the dollar and into your portfolio.

There’s also the phenomenon of cryptocurrencies.

Once considered somewhat of a joke by big-name investors, the attitudes around Bitcoin and other digital currencies has taken a drastic turn in 2020. 

With global markets volatile and the future opaque, a currency independent politics, governments, and stock markets look pretty appealing nowadays.

There is no doubt Bitcoin and cryptocurrencies are gaining traction. Major companies like Microsoft, Shopify, Amazon (through a third-party app) now accept Bitcoin, with more on the way.

PayPal plans to roll out Bitcoin and other cryptocurrencies on it’s apps (including ultra-popular Venmo) in 2021. 

The upside to foreign and cryptocurrencies compared to other alternative investments is that it is highly liquid. You can also invest just a few dollars if you want to, so the commitment level is low.

Will 2021 be the year that Bitcoin and cryptocurrencies become the global currency standard? 

That could be a multi-million dollar question.

Looking ahead to 2021

While no one really knows what the future holds, everyone’s bracing for some choppy waters ahead. That warrants branching into investments outside of the stock market and other traditional investments.

The world is eager to get back to normal. But as events continue to unfold, it’s becoming increasingly probable that ‘normal’ might look a little different in 2021. Some of the changes brought on this year are fundamental, long-lasting shifts. 

And where there are shifts, there are usually some millionaires in the making.

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