“Alternatives” is a catch-all term for investments outside the traditional trio of stocks, bonds and cash. Large pension funds and university endowments use them heavily. Individuals are increasingly being offered them too, which makes it worth knowing their trade-offs.
Main types
- Real estate: rental property, real estate investment trusts (REITs), real estate crowdfunding. See real estate for beginners.
- Private equity and venture capital: stakes in companies not listed on a stock exchange.
- Private credit: loans to companies outside public bond markets.
- Hedge funds: pooled funds using strategies such as short selling, leverage and derivatives.
- Commodities: gold, oil, agricultural products, usually through futures or ETFs.
- Collectibles: art, wine, watches, cards, classic cars.
- Crypto assets: discussed in the risks of cryptocurrency.
- Infrastructure and farmland, often through specialized funds.
The pitch
- Diversification: some alternatives move differently from stocks and bonds.
- Potential for higher returns or income, especially from private markets.
- Inflation protection from real assets.
The catches
- High fees. The classic hedge fund model was “2 and 20”: 2% of assets a year plus 20% of profits. Many private funds still charge well above index fund costs.
- Illiquidity. Money may be locked for years, or withdrawals limited to small amounts per quarter, as some non-traded REIT investors discovered when withdrawal requests exceeded limits.
- Opaque valuations. Prices may be estimated rather than set by a market, which can make returns look smoother than they are.
- Complexity and conflicts. Hard to compare, easy to oversell.
- Access rules. Many private offerings are limited to accredited investors (roughly $200,000 income or $1 million net worth excluding your home).
- Collectibles carry storage, insurance, authenticity risk and a higher federal tax rate on long-term gains (up to 28%).
How individuals can get exposure
- Publicly traded REITs and commodity ETFs, buyable in any brokerage account.
- Interval funds and other registered funds that hold private assets, with limited liquidity.
- Direct ownership (a rental property, gold coins).
How much is reasonable?
For most people, alternatives are optional. A diversified mix of low-cost stock and bond funds already captures most of the benefits of diversification (diversification explained). If you add alternatives, keep them a modest slice, understand exactly how you get your money out, and compare total fees.
The SEC’s Investor.gov page on hedge funds explains how private funds differ from regular mutual funds.
