By Sean Gerlin, CFP®, ChFC®, CLU®
When most people think of investments, they think stocks and bonds. But there is a whole world of investments out there beyond the conventional asset classes. As a commercial real estate broker, you have some exposure to this world through your job, but you may be unfamiliar with the vast array of alternative investments that exist beyond the real estate sector.
People often say, “What you don’t know won’t hurt you,” but that doesn’t apply in this case. When it comes to alternative investments, not knowing or not utilizing them properly could cost you in the long run. Here is everything you need to know about alternative investments and how to determine if they make sense for your portfolio.
What Are Alternative Investments?
An alternative investment is simply an asset that doesn’t fit into one of the conventional investment types, namely stocks, bonds, and cash. There are many alternative investments, but some of the most common include cryptocurrency, real estate, private equity, and hedge funds. In general, the point of an alternative investment is that it behaves differently than stocks and bonds, which adds value to your portfolio by acting as a diversifier.
Cryptocurrency & Digital Assets
Cryptocurrency (commonly called “crypto”) is a digital asset that is stored in a computerized database ledger and uses strong cryptography and encryption keys to secure transaction records. Unlike typical currencies, crypto is not backed by any country or centralized bank, but, rather, it is under decentralized control. (1) They are also designed to be free from government manipulation and control, and in general remain entirely digital, and therefore intangible.
There are many types of digital assets in the market today, but the three biggest contenders are Bitcoin, Ethereum, and Binance Coin. Cryptocurrency is becoming increasingly popular as a way to purchase Non-Fungible Tokens (NFTs). An NFT is another type of digital asset that is also encoded through cryptography and used to represent real-life assets like music, artwork, and videos.
NFTs are gaining steam in the alternative investment world but like other digital assets, they carry inherent risks. Several investment alerts have been issued about cryptocurrency in particular by American regulators, including the SEC and FINRA, among others. And it is still a new investment with a very short and rather volatile history. (2)
Despite its speculative nature, crypto is growing in popularity and is becoming an increasingly mainstream alternative investment. If there is room in your portfolio for more high-risk, high-reward investments, cryptocurrencies may be the right choice for you.
Investing in property is a popular way to add diversity to your portfolio either by owning rental properties or investing in a Real Estate Investment Trust (REIT). Arguably the most familiar alternative investment for commercial real estate brokers, REITs are closed-end funds that buy, develop, manage, and sell real estate assets. REITs can be publicly traded and are easy to buy like any stock on the exchange. REITs can also be non-traded and more concentrated, which may shield you from volatility when the markets go through more violent corrections.
Depending on your current asset allocation, additional investments in real estate may lead to a heavily concentrated portfolio. Since you work in real estate already, you don’t want to put all your financial eggs in one basket by overly investing in one sector. This could make your portfolio more susceptible to large swings if the real estate industry were to experience a market downturn. This is why it’s important to be specific about the types of private real estate you invest in.
Many companies receive investor capital even while they remain private. Private equity includes investment in start-ups, venture capital, and financing growth phases of a privately held company. Private equity firms use investors’ money as a way to loan capital to promising private companies in return for an ownership interest. Then, when the company goes public or is sold, the capital is returned to the investors. Private equity investments typically come from institutional investors or accredited investors who are able to invest large sums of money upfront.
Hedge funds use pooled capital to invest in a variety of asset types in both traditional and non-traditional markets. This versatility provides a greater level of diversification than almost any other investment. Hedge funds may use high-risk strategies such as long-short equity, distressed assets, arbitrage, and macro-trends.
The difference between hedge funds and private equity is that hedge funds invest in public equities and have greater liquidity and redemption frequencies, so it’s easier to get your money out. While increased liquidity is certainly a benefit, hedge funds as a whole are not subject to the strict regulation of the SEC. This means there is often less oversight and less transparency around how your funds are being managed.
Benefits of Alternative Investments
There are several benefits of alternative investments, including:
- Low correlation: Alternative investments have a low correlation with the typical asset classes that make up the majority of the stock market. This can add much-needed diversification to your portfolio and potentially improve your overall rate of return by mitigating downside risk. Hard assets like real estate may have an inverse relationship with stocks and bonds, especially during periods of higher inflation. Because of these differences in behavior, including them in your portfolio may provide broader diversification, reduce risk, and increase returns.
- Tax advantages: If structured properly, alternative investments can offer tax advantages. For instance, private equity and hedge fund investments are considered partnerships. As an investor, you can become part owner of the fund, and any tax benefits available to the fund can get passed directly to you. Additionally, some alternative investments can be owned through retirement accounts, meaning your investment may be considered tax-deferred or even tax-free.
What to Consider
Despite the advantages, there are important drawbacks to consider before adding alternative investments to your portfolio. These include:
- Lack of liquidity: While some alternative investments offer income right away, many of them are wrapped up in a physical asset, which makes it difficult for investors to receive an immediate return. You may have to commit your funds to the investment for several years before having access to any form of liquidity.
- Too expensive: Some alternative investment strategies have very high barriers to entry. For example, private equity funds and hedge funds are often only available to institutional investors or accredited investors (net worth of at least $1 million, or $200,000 annual income). As a commercial real estate broker, you have a good chance of exceeding the income threshold, but then you have to contend with the higher management fees.
- Increased volatility: Since many alternative investments are concentrated in the start-up and private sectors, there is a chance for greater volatility than with a traditional asset class. While there can be incredible gains associated with the alternative investment, there can also be very dramatic losses. You must be willing to accept and prepare for the potential downside risk that comes with alternative investments.
Are Alternative Investments Right for Your Portfolio?
Alternative investments can be a great addition to your portfolio, but they are not a good fit for everyone. Working with a financial professional is crucial to ensure you don’t expose yourself to unnecessary risk. At Envision Wealth Planners, we are familiar with the needs of commercial real estate brokers and we have the knowledge to help you decide if alternative investments are right for you. Schedule a no-obligation introductory phone call or reach out to me at email@example.com or 407.720.6535 to get started today.
Sean Gerlin is founder, principal, and a financial planner at Envision Wealth Planners, an independent financial advisory firm founded on the core values of family, honesty, and a determination to be a master of the trade. With almost 10 years of experience, Sean specializes in serving affluent families and commercial real estate executives and brokers, providing comprehensive, customized financial guidance and services for their complex financial needs. Sean acts as a family CFO, managing and coordinating the many moving pieces of his clients’ financial lives. Sean is known for his commitment to building long-term relationships and paying personal attention to each client. He is passionate about helping his clients experience the relief that comes from having organized and well-planned strategies and portfolios, and he desires to help them by shouldering some of the financial burdens they face.
Sean has a bachelor’s degree from the University of Florida and holds the CERTIFIED FINANCIAL PLANNER™, Chartered Financial Consultant®, and Chartered Life Underwriter® certifications. When he’s not working, you can find him cooking, eating good food, traveling, coaching his son’s baseball team, or playing golf. He loves spending time with his wife, Nicole, and their two kids, Avery and Will, and entertaining friends in their beautiful backyard. To learn more about Sean, connect with him on LinkedIn.