Top10 Safest Alternative Investments
As volatile as the stock market can be, many investors have been looking into safer ways to invest their money. So, “alternative investments” have become increasingly popular. An alternative investment is any investment other than the three traditional asset classes: stocks, bonds and cash. But alternative investments don’t take the place of those more traditional assets. Investors shouldn’t sell their stocks, cash out their savings accounts and put all their money in these less traditional options. Most financial experts agree that alternative investments are best when used to diversify financial portfolios. In other words, instead of putting all of your money in stocks, put some in stocks, some in bonds, and some in alternative investments like hedge funds, private equity, or even fine art and wine.
Historically, many of these alternative investments have been more popular among high-net-worth individuals and institutional investors, such as private endowments. That’s because many alternative investments require larger initial investments than stocks or bonds. Also, while it may not be the case with fine art, wine or other collectibles, almost all alternative investments are less liquid than traditional investments, meaning they can’t be cashed in as quickly or easily. But despite that, there are some advantages to alternative investments. Read on to find out those advantages, and educate yourself before you dip your toes into those murky waters.
Fine art can be a good investment because, historically, the price fluctuations in the art market don’t reflect the ups and downs of traditional stock and bonds. During the second half of the 20th century, the value of art (based on the Mei Moses Fine Art Index), steadily increased at an average of 10.5 percent annually [source: Gross]. However, while the stock market and the art market don’t usually peak and fall at the same time, art still experiences its own shifts that can make investing risky. For example, fine art sales boomed during the late 1980s due to a surge in investment from Japanese investors, and again in the mid-2000s [source: Woliver]. But even the thriving art market couldn’t escape the 2008 global financial meltdown, though. The market has experienced a serious slump in the two years following, as well [source: Johansmeyer].
To buy paintings or sculptures in some of the top galleries and auction houses, investors should start with at least $10,000 [source: Johansmeyer]. But buyers can enter the market with much smaller amounts (closer to $500 or $1,000) if they are willing to take a gamble on smaller, undiscovered artists, or on less expensive media like photography and lithography [source: Woliver]. Of course, the big advantage of art as an investment is that as long as you buy what you appreciate, you can always just enjoy it for its beauty, even if you don’t see big financial returns.
Investors in fine wines can expect to make a steady return between 6 and 15 percent annually over the long term [source: Reiss]. Prices of certain vintages, and of fine wines in general, fluctuate from year to year. But prices of wines from the most sought-after vineyards and vintages tend to increase eventually as the supply becomes scarce [source: Opdyke]. Wine connoisseurs and collectors are notoriously picky, so investors need to stay on top of things like which vintages will make good investments. Wines from the Bordeaux region and other parts of France provide more reliable returns, since they are prized among collectors, but many Burgundies, Italy’s Super Tuscans, Spanish reds and California’s cult cabernets also make good investments [source: Opdyke]. There are also services, like Wineprices.com, that track wine prices both individually and as aggregates.
Even with some of the most expensive wines, you’ll have to invest in large quantities to make a sizable return. And the wine must be stored in a temperature-controlled environment to keep it in optimal condition. Auction buyers can tell if wine has been stored improperly [source: Gobel]. The bottles should be stored at temperatures between 55 and 58 degrees Fahrenheit (12.7 and 14.4 degrees Celsius) and at 60 to 75 percent relative humidity [source: Opdyke]. Wine coolers can be purchased commercially for several thousand dollars, but there are also companies that will store wine for you. Finally, investors should insure their collections, and keep careful purchase records to satisfy finicky auction buyers [source: Opdyke].
here are two types of coins to consider when buying coinage for investment purposes. Bullion coins are minted by national governments, usually in gold. Examples include the American Gold Eagle, the South African Krugerrand and the Australian Nugget [source: Financial Web]. These coins are not collectible, because they don’t derive their value from their scarcity. They can be bought and sold through reputable gold dealers for a price relatively close to the commodity price of gold. (The price of a coin will be marked up when you buy it, and marked down when you sell it since gold dealers need to make profits on their transactions [source: Picerno].) In late 2010 and early 2011, high performance in the per-ounce price of gold made bullion a reasonably safe investment.
The second type of coins used for investments are collectible or numismatic coins. These coins are valued, not for their weight in precious metals, but because of their scarcity. Popular collectible coins include Morgan dollars, Walking Liberty half dollars and certain Buffalo Nickels. Many factors influence how valuable a particular coin might be, including condition, which mint mark it carries and the year of issue. Mint condition coins are always more valuable than coins that are heavily worn [source: Coin World]. Certain years of coins had fewer mintings, making them more rare and valuable [source: Coin World]. For example, some 1918/7-D Buffalo Nickels could be worth as much as $285,000 because the coins were printed with overdates when then 1917 die was impressed with a 1918 hub [source: PCGS].
In the coin market, the rarest coins tend to provide huge returns (upwards of 100 percent of their value in a year), while more marginally rare coins provide only modest returns (sometimes as low as 0 percent in a given year) [source: Knaus]. With any investment coins, find a dealer with a good reputation and inspect the coins carefully before making a purchase, as there are always forgeries circulating.
Commodities include resources like crops and livestock, fossil fuels such as oil and coal, and precious metals like copper and gold. And the commodities market is one of the most volatile, since unpredictable natural disasters and world events have a direct impact on prices. Take crops, for example. A drought one year can send the price of a particular crop soaring because scarcity triggers an increase in demand. The next year, a huge surplus could make the price of that commodity fall dramatically. Because of their unpredictability, commodities typically make better long-term than short-term investments [source: Picerno]. The economic uncertainties after the 2008 recession drove up prices of food in the grocery stores and gas at the filling station, which means commodity prices rose as well. Commodities like oil, corn and gold climbed dramatically in 2010, so investors who bought into commodities in prior years have seen impressive returns [source: Wallace].
The safest way for individual investors to take advantage of the rising prices of commodities is to buy into exchange traded funds (ETFs); these are essentially mutual funds that purchase commodities or invest in commodity producing businesses [source: Wallace]. The safest ETFs purchase several different commodities, rather than focusing on one. ETFs can eliminate some of the uncertainty from choosing which commodities might rise and fall at a given moment [source: Picerno].
Private equity is investing in a company that does not issue public stock. Investors contribute capital to a company and then receive returns on their initial investment once the company reaches a certain stage, often an initial public offering of stock or a merger [source: Wells Fargo]. Private equity investment has often funded start-up companies in high tech fields like telecommunications, biotechnology and recently, alternative energy [source: Lambert]. The success or failure of an investment depends on how well a start-up company does, which is obviously a risky proposition even in a good economic environment. For this reason, high-net-worth individuals and venture capital firms have usually been far more active in private equity than small investors. Often, the investors have a hands-on role in shaping the management strategy of the growing company.
Individual investors have a few options for investing in private equity, but one relatively safe option is to work with a private equity firm to join a pool of investors. However it’s extremely expensive: Many firms require a buy-in of $250,000 to $25 million [source: Lambert]. The safest option is to purchase shares in exchange-traded funds, which purchase interests in many private equity ventures at once to decrease investment risk [source: Lambert]. There are good reasons to put a portion of an investment portfolio in private equity. Although returns suffer like most areas during economic recession, indexes of private equity funds have fared better than the stock market both during the first half of 2010 and during the 20 years prior [source: Cambridge Associates].
Like other types of investment funds (e.g., mutual funds), hedge funds collect money from multiple investors and spread the communal capital into various investments to increase the chances of a return on investment. Hedge funds are less regulated than other funds by the U.S. Securities and Exchange Commission, so fund managers are able to make investments in a very broad range of financial instruments. The Dodd-Frank Wall Street Reform and Consumer Protection Act passed in 2010 created some new requirements and restrictions for hedge funds, but focused more on reporting and transparency than on where fund managers make their investments [source: Cadwalader, Wickersham and Taft].
Hedge fund managers can invest in stocks, commodities, derivatives, futures, options and all types of financial instruments. This broad leeway often brings positive returns. In 2010, hedge funds around the world climbed while many stock markets fell or made modest gains [source: Yamazaki]. However, hedge funds have a relatively steep barrier to entry in the form of minimum investments of $500,000 or more and expensive fee structures [source: Sherman]. Those who can afford to invest in hedge funds should be cautious. Not all hedge funds are volatile and high-risk, but investors should research the fund and its manager before making a commitment [source: U.S. Securities and Exchange Commission].
Similar to hedge funds, managed futures funds are run by fund managers who pool investors’ money and invest it in various financial instruments. However, managed futures are more regulated than hedge funds. Managed futures funds are investments in futures or options in the commodities, currencyand interest rate markets [source: J.P. Turner & Company]. Futures and options are essentially bets on how a particular equity or investment will perform. A future is a contract to buy a certain amount of a commodity, stock or even currency at a set price at a set date. The buyer or the seller can then make money, depending on how the actual price rises or falls compared to the agreed upon price. Options are mostly the same, except that they provide the buyer with an option to buy the investment, not an obligation.
Managed futures funds are also more accessible than hedge funds. While investors are typically high-net-worth, many managers have low minimum investments in the $5,000 range [source: J.P. Turner & Company]. Managed futures can help keep a portfolio diverse, since they usually do not follow the trends of other markets. However, the nature of the funds as a form of predicting the performance of other markets makes them very high risk [source: Morgan Stanley Smith Barney].
A specific type of private equity, venture capital focuses on start-up businesses that are at an extremely early stage in their business development. Venture capital firms provide start-up money for these companies and see a return when the company issues stock, or when another company purchases it. That return on investment usually does not come through for about 10 years, if at all [source: National Venture Capital Association]. Because venture capital firms invest at these companies in such an early stage, their investments are quite risky. However, they spread their capital over a broad array of companies to minimize that risk for the entire firm [source: Mendicino].
On the downside, most venture capital funds require a high minimum investment and a net worth of around $1 million for individual investors. Venture capital is also extremely illiquid; investments are usually tied up for a number of years before they can be converted to cash [source: Mendicino].
Financial derivatives are a category of securities that include futures, options, forwards and swaps. Basically, derivatives are an agreement between an investor and another party that will be paid out when a certain asset reaches a certain level. That definition might seem vague, but only because derivatives are a very broad category of security [source: Rutledge]. In a futures contract, the investor agrees to buy an asset at a given price on a certain date. An option is similar, only the purchase is optional. A swap is when two parties exchange an asset, often to obtain a preferential interest rate [source: Rutledge].
Derivatives have become controversial because economists have linked the 2008 credit crisis to failures in the derivatives market [source: Summers]. However, derivatives are often used as a way to decrease risk in an investment portfolio. For example, a fund manager might use foreign currency futures to offset potential losses in investments made in a foreign country, or use an interest rate swap to take advantage of changes in interest rates [source: Rutledge]. Some derivatives (like options and futures) are relatively accessible for individual investors. Others (like many swaps) are usually only traded by large institutional investors.
Historically, real estate has been a very popular alternative investment. Of course, the 2008 crash in the U.S. real estate market made many nervous about investing in real estate. But with prices still extremely low, real estate can be a good investment opportunity. The three most accessible ways to invest in real estate are to buy rental property as an individual, to join a real estate investment group or to buy shares in a real estate investment trust (REIT). Buying rental property can usually provide steady, reliable income if you find the right tenants. However, there are also expenses like property taxesand general upkeep that can limit profits, as well as huge investments of time and effort.
Real estate investment groups offer a more hands-off, low-risk method of investing in real estate. A group of individual investors contributes money to a company that purchases a property (usually something like a condo development). The company manages the property in exchange for a portion of the monthly rent [source: Beattie]. Another option is the real estate investment trust (REIT). They provide extremely accessible ways for individuals to invest in real estate. An REIT is a group that invests in various real estate properties, and receives preferential tax treatment from the IRS in exchange for paying most of its income to shareholders [source: U.S. Securities and Exchange Commission]. Investors can purchase shares of REITs on public exchanges, making them one of the more liquid alternative investments. Another upside is that, like stocks, shares in REITs pay out regular dividends [source: Beattie].