Alternative Investment

Definition

Alternative investment refers to financial assets that do not fall into the conventional categories of investment like stocks, bonds, or cash. These include commodities, real estate, private equity, hedge funds, infrastructure, and collectibles among other types. They are generally characterized by their complexity, low liquidity, regulatory oversight, and the skills needed for investing.

Phonetic

The phonetic pronunciation of “Alternative Investment” can be written as: Alternative – ɔːlˈtɜːrnətɪv Investment – ɪnˈvɛstmənt

Key Takeaways

1. Diversity in Portfolio: Alternative investments offer a broader set of investment options and can provide diversity to your portfolio. They include assets like real estate, private equity, commodities, hedge funds, and more. These investments are not correlated with traditional stock and bond markets, which might help reduce the risk and provide better returns.
2. Potential for High Returns: Alternative investments often have the potential for high returns. Because they’re less regulated and often more complex, these types of investments tend to offer higher potential returns than traditional investments. However, it’s crucial to remember that this greater potential for profit usually comes with a higher level of risk.
3. Liquidity Risk: A significant characteristic of alternative investments is that they may lack liquidity. This means that these investments might not be quickly or easily converted into cash without a loss in value. This can limit their accessibility and could be a concern for investors requiring regular cash flow or those who may need to quickly adjust their portfolio.

Importance

Alternative investments are important in the realm of business and finance as they provide additional methods to diversify an investment portfolio. This diversification is imperative since it can potentially mitigate risk and enhance returns. Alternative investments include private equity, hedge funds, real estate, commodities, and more, which do not fall under traditional asset categories like stocks, bonds, or cash. They often have a low correlation with standard asset classes, this means even if traditional markets are performing poorly, alternative investments may thrive. Hence, although they might involve more risk and are usually less liquid, alternative investments can provide substantial benefits when incorporated into a well-balanced portfolio.

Explanation

Alternative investments serve a paramount role in diversification of an investor’s portfolio and potential to mitigate risk. Traditional investments such as stocks, bonds, and cash often move in predictable, correlated ways reacting to factors like interest rate changes, economic indicators, or corporate earnings. However, alternative investments often defy these patterns, offering investors unique opportunities to diversify their holdings and decrease the potential risk. This may reduce the volatility of the portfolio and enhance long-term returns. They are designed for higher net worth and institutional investors who have a broader range of investment options and larger portfolios which can sustain the complexity and potential risks of these investments.These investments are used in various circumstances and strategies dependent on the investor’s goals. Private equity, hedge funds, real estate, commodities, and tangible assets are all examples of common types of alternative investments. They have gained popularity as they often have a low correlation with traditional asset classes, providing an efficient means of diversifying a portfolio. Often, alternative investments may provide a hedge against inflation or protection in falling markets. They can also offer increased returns, but it’s important to remember that greater potential returns can also mean a higher level of risk. Due to their complexity, these types of investments often require significant expertise and understanding, which is why they are usually managed by specialized management teams.

Examples

1. Real Estate Investment: One of the most common types of alternative investments is real estate. This involves purchasing properties either for rental income or for selling at a later date for a higher price. This category can include residential real estate (houses, condos, apartments), commercial real estate (offices, hotels), and industrial real estate (warehouses, factories).2. Hedge Funds: These are pooled investments that use different strategies to earn active returns for their investors. Hedge funds may invest in a diverse range of assets, but they are most often associated with investing in securities such as stocks and bonds. They are less regulated than other types of investment vehicles like mutual funds. 3. Private Equity: This type of investment involves directly investing in private companies or conducting buyouts of public companies that result in a delisting of public equity. Investors in private equity need to commit their money for long periods of time while companies are developed and groomed for a profitable exit (usually through a sale or an initial public offering). All of these types of investments are considered “alternative” because they involve more complex structures and strategies than traditional investments like stocks and bonds. They can also involve higher risk.

Frequently Asked Questions(FAQ)

Related Finance Terms

• Hedge Funds
• Private Equity
• Real Estate Investment
• Commodity Futures
• Venture Capital

Sources for More Information

• Investopedia
• Blackrock
• Schwab
• The Motley Fool