Alternative Investments Explained: Should we invest in them?

Alternative Investments

We call alternative investments, those are not the usual bonds, stocks, or cash. Many investments will fall in this category, such as gold, real estate or cryptocurrencies.

Investors usually invest in alternative investments for different reasons:

1. Some alternative investments can have higher returns than stocks
2. Some alternative investments can protect against a crash in the stock market (or bond market) with a low correlation.
3. Some alternative investments can simply provide diversification.
4. Some alternative investments are more tangible.

So, there are many possible reasons to invest in alternative investments. But the question is: should we all invest in alternative investments? And if yes, in which of them?

We will explore the different categories of alternative investments and their pros and cons.

Real Estate

The most well-known alternative investment is probably real estate. Instead of investing in a company, we invest in a property. This is generally a flat or multiple flats because the returns on a flat are generally higher than the returns on a house.

I should mention that I am not talking about a house or apartment where you live. Because, your residence is not an investment since you need it to live. So, we only consider rental properties as alternative investments.

The main advantage of real estate (often the only one) is leverage. You usually do not buy a rental property cash, but with a mortgage. And with a mortgage, you get a lot of money from the bank. So, you are using the bank to provide leverage. And the advantage of leverage is that you are optimizing your returns based on how much you are putting in.

On the other hand, the barrier to entry is quite high because you require a lot of money to invest in a rental property directly. Even if you only put down 20% on the property.

Furthermore, there are many one-time costs. You will need to pay for the land register and the notary, which are both costly. So, you need to make this a long-term investment if you want to make money.

And real estate is also the alternative investment that takes the most time. You will have to manage the house and make sure you always have a tenant. When there is a problem, you will have to handle it, and you may have to keep the property renovated over time.

There are other ways to invest in real estate. If you invest through ETFs, for instance, you will have a much lower barrier to entry. On the other hand, you are losing a lot of the upside of real estate (and a lot of the returns). But this allows you to diversify with little money and no large costs.

I am not totally convinced by rental properties in Switzerland. The fees are very high to buy and the prices of properties are also very high. Banks are also becoming stricter and stricter with mortgages for rental properties. The returns on the property are not very high compared to the entry costs and the time necessary for this investment. I think it makes more sense in other countries.

At this point, we do not have any rental properties. But in the future, we may have one.

Gold and other precious metals

Precious metals are among the most used alternative investments. The most famous of them (as an investment) is gold. Many people invest in Gold, either through physical gold or through ETFs.

Gold and other precious metals have the advantage to being physical. You can touch it, and you know exactly what you bought. It is also easy to buy physical gold.

The main disadvantage is that you need to find a way to store precious metals. If you have a significant investment, you probably do not want to keep it in your home because that would be dangerous.

While it is easy to buy, you have to be careful about the margin of the seller and the spread. There are some massive variations between shops and this will make a lot of difference in the price. You can also sell gold quickly, but if you are not cautious, you may also not get the best price.

Except for the recent period, investing in gold has not been very profitable. As I write these lines, gold is at an all-time high. But in the past, it has been stagnant or even decreasing for many years. There are many periods where it took more than 10 years to see a profit.

Gold and other precious metals are also available in other forms. You can invest in ETFs, futures, or funds. But in each case, you are increasing the fees and lowering the profits, but simplifying your investments.

As an alternative investment, I am not convinced by precious metals. Having some physical gold may increase the safety of your money. However, having a large allocation to precious metals in your portfolio will reduce your returns.

Personally, we have bought a few physical gold coins, but this does not represent a significant portion of our allocation (about 0.5%). We may buy more coins in the future, but this is not yet planned.

If you want more detail, I have an entire article about investing in gold.

Commodities

Commodities are physical goods used in the industry. For instance, crude oil and wheat and even orange juice are commodities.

Usually, gold and precious metals are considered commodities. But I have discussed them separately because they are the most popular of commodities, and they are easier to invest in than other commodities.

Commodity traders are typically using future contracts to trade in commodities. But this is an advanced technique for trading. Conventional investors will generally use ETFs to trade commodities.

One advantage of commodities is that they usually have low correlation with stocks. Additionally, they are a hedge against inflation since they typically follow inflation.

On the other hand, returns on commodities are historically lower than on stocks. And ETFs (for private investors) have a hard time tracking precisely commodities (significant tracking error) and are pricier than stocks ETFs. There is also no cash flow on commodities.

I think commodities are best left to professional investors. Precious metals are interesting, especially in their physical form, but I do not think commodities should be part of everybody’s portfolio.

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The most recent of the alternative investments is probably also the investment that makes the most noise: cryptocurrencies. It has been here for less than 20 years, but it has proved highly disruptive.

Some crypto enthusiasts are even investing solely in cryptocurrencies. However, when you are investing in cryptocurrencies, you are not investing in any asset that may bring value, only in a currency. We could consider that we are investing in a tool that may disrupt centralized finance, but it is still only a tool.

Another issue of investing in crypto is that it is more complex to understand what is going on. And it is also easier to get scammed. With cryptocurrencies, you need to take security very seriously and protect your wallet. In fact, the best security you can achieve with your cryptocurrencies is to handle your wallet yourself.

On the other hand, cryptocurrencies have proved to generate very high returns. Every time Bitcoin hits a new high, we hear people say that this will never happen again, and yet, this does happen. The rise of Bitcoin since its inception in 2008 has been incredible. This is the main reason people are investing in cryptocurrencies (except for the people who invest because of decentralized finance).

But high returns in crypto come with high risks. The volatility of Bitcoin (and most cryptocurrencies) is much higher than a standard stock market index. So, if you want to invest in crypto, you need to be prepared for very significant daily swings. It is not uncommon to see daily changes of more than 10%.

If you are planning to invest in cryptocurrencies, I would recommend being cautious and sticking to the most established coins. I would personally not invest in anything other than Bitcoin and Ethereum myself (and only a small percentage in Ethereum). You should start with a small portion of your wealth and maybe scale up slowly if you find that this fits your investing style.

If you are interested, I have an article about how cryptocurrencies work. Or, if you prefer, you can read my review of Swissborg to get started. We have invested some blog money into cryptocurrencies to try it out.

Private Equity

Private equity means investment in companies that are not public (not on the stock market). So, we invest money directly into private companies.

Generally, private investors do not have direct access to private equity. The main entities that access private equity are venture capital firms or institutional investors.

These days, private equity is often marketed to private investors. It has become easier to access private equity, and multiple Swiss actors are also offering access to private equity deals at a relatively low entry point.

It is entirely true that private equity can generate very high returns. Venture capitals can often make a lot of money from these deals by betting on a good private company. And it is also a way to access companies that are not on the stock market.

However, private equity is not great for private investors. The main issue is that the best deals are not available to private investors. So, we are left with the deals that the priority investors did not want. Additionally, since we cannot access these deals directly, we have to go through intermediaries (usually several of them) and this means there are some expensive fees.

In all cases, investments in private are not very liquid. Often, the investments are locked in for multiple years.

Overall, I am convinced that private equity is not a good deal for private investors. If you are an ultra-high net worth individual, you may have access to better deals, but most investors are simply left with the leftover deals of wealthier investors. I do not consider private equity a great alternative investment.

Art and other collectibles

A form of alternative investment that has become more and more popular recently is the investment in collectibles. These last few years, there have been many services proposing investing in art, watches, cars or even wine.

In the past, investing in art and collectibles was reserved to wealthy individuals. These days, it appears that it is accessible to everybody (on the same model as private equity). However, standard investors will pay a price for not being able to do the collections themselves, since it is costly to buy and store these collectibles.

It is possible to achieve high returns with art. But it is also very difficult to price these collectibles, there is no standardized valuation method. And these assets are very illiquid (difficult to sell).

Like private equity, I think that private investors only get the deals that wealthy investors and collectors did not want. I do not see art as a good alternative investment.

If you are a collector, it is obviously a different story. But it is difficult to make money from a collection even if you are passionate (especially since passionate people often have a difficult time selling). Finally, it is also worth mentioning that passionate people have a tendency to overvalue their assets.

Personally, I think investing in art and collectibles is not a good idea. You need to know the market really well to make money in this category. And if you use some existing platforms to invest, a lot of your returns will be eaten by fees.

P2P Lending

Peer-To-Peer (P2P) lending is lending money directly to other people instead of them having to go through banks. You would get monthly payments of cash, so the advantage of this investment is to have cash flow.

About ten years ago, we have seen many new platforms in Europe start such services, such as Mintos or Bondora. I have talked about a few of them in the past. At the beginning, all was well. But then, many of these platforms started to collapse. The reasons is that many people defaulted on their debts and investors were not as protected as they thought.

Additionally, many of these platforms were actually scamming people and were Ponzi schemes. We have also seen that at the same for platforms doing P2P investing in real estate or other projects, another form of P2P lending.

I do think people should not invest in P2P lending. The risks are too high, and the regulations are too little. I invested myself in the past and I regretted it. Lending is best left to banks, whose job it is.

Summary

To summarize, we can put all these alternative investments together in a table to recap their main points.

Conclusion

There are many alternative investments available. Each of these alternative investments has some advantages and disadvantages. But you do not really need to invest in any of them if you are satisfied with stocks and bonds.

If you want to diversify outside conventional investments, there are some decent alternative investments. For instance, if you want some cash flow and have a large amount of cash to invest, real estate can be a good alternative investment if you are willing to put in the time necessary. Or, if you want a lower entry, gold (and other precious metals) can also be interesting, especially in physical form. Finally, if you want diversification and high returns (and high risk), you could consider cryptocurrencies.

On our end, we do not plan to scale up our alternative investments. We have some physical gold and some cryptocurrencies, but they represent a minimal portion of our total investments. And in the future, we may have some real estate as well.

I strongly believe that alternative investments should only form a small portion of the overall portfolio. If you are not yet investing, you should first consider investing in stocks. And if you do not know how to start, you can read our guide on starting to invest in the stock market.

What about you? Do you have any alternative investments?