What’s in a Word: “Alternative” Investments
“Alternative” is a word we’ve heard a lot of lately (think “alternative facts,” “alternative energy”). If you Google “What are alternative investments?” you’ll get about 13 million results. That’s a lot of answers to what sounds like a pretty simple question.
However, as many investors know, the definition of this category is far from simple. Real estate, private equity, precious metals, currencies, and even wine or art can all be considered alternative investments—and clearly have little (or nothing) to do with one another.
While it’s true that the alternatives category can be tough to pin down, at PENSCO when we think about alternatives we think about these characteristics:
1. Alternatives are not traded on an exchange. The easiest way to define alternatives is to say what they are not versus what they are. Specifically, they are not traditional investments like stocks, bonds and cash. Almost any other tangible asset (e.g. coins) or financial asset (e.g. venture capital) is most likely considered an alternative investment.
2. Alternatives are diversifiers. According to this article in Investopedia, alternative assets — while incredibly varied — have a low correlation coefficient, meaning they can help smooth out the market fluctuations with equities and fixed income by not moving in the same direction as stock market investments. In fact, in our 2015 client survey our clients told us the most popular reason for seeking non-traded alternatives for an IRA portfolio is to improve diversification and risk-return characteristics.
3. Alternatives have always been able to be held in retirement account. Yes, this is not new news! In 1974 ERISA (the Employee Retirement Income Security Act) was enacted into law and the Individual Retirement Account was born. Since then, an investor has been able to invest in alternatives in their IRA—but most brokers or benefit plans limited your selection to stocks, bonds, cash, and mutual funds—so most people just don’t know this is an option. While a self-directed IRA can give you more control and flexibility when it comes to investment selection, it also requires a more hands-on approach so you don’t run afoul of prohibited transactions rules related to disqualified persons.
4. Alternatives usage is on the rise. It used to be that alternative investments were only for institutions and the extremely wealthy, but that has shifted over the past several years and is expected to continue as a result of new initiatives such as the introduction of Regulation A+ of the JOBS Act. As a result, even so-called “average” investors have been more open to idea of alternatives in their portfolios. And, as we saw in our 2016 client survey, more investors continue to want to invest in “what you know” – and that just might be real estate or private equity – which clearly isn’t alternative to them.
This Blog does not provide investment, tax, or legal advice nor does it evaluate, recommend or endorse any advisory firm or investment vehicle. Investments are not FDIC insured and are subject to risk, including the loss of principal.
PENSCO Trust Company performs the duties of an independent custodian of assets for self-directed individual and business retirement accounts and does not provide investment advice, sell investments or offer any tax or legal advice. Clients or potential clients are advised to perform their own due diligence in choosing any investment opportunity as well as selecting any professional to assist them with an investment opportunity. Alternative investments are not FDIC insured and are subject to risk, including loss of principal. PENSCO is indirectly affiliated with a registered broker dealer and with a licensed small business investment company through Opus Bank (“Opus Affiliates”). Other than the Opus Affiliates, PENSCO is not affiliated with any financial professional, investment, investment sponsor, or investment, tax or legal advisor.
Editor’s Note: This is an updated version of a post we originally published in March 2014. We welcome new comments and questions below.