Alternative investments fall outside the traditional markets of publicly traded stocks and bonds. The broad category of alternative investments includes private equity, private credit, real estate, infrastructure, hedge funds and commodities, as well as physical assets such as art and other collectibles.

Investors may add alternatives to a portfolio for several reasons. For example, alternatives can provide diversification beyond stocks and bonds, potentially generate income, or offer additional opportunities for growth. Some alternatives may also help offset the effects of inflation or perform differently during various market cycles. Alternatives come with their own unique risks, however, and they can be more complex than traditional investments.¹

Common types of alternative investments

Alternative investments come in many forms, including:

• Private equity: Investments in privately held companies that aren't traded on public stock exchanges.
• Private credit: Financing provided to companies by nonbank institutions through privately negotiated loans and bonds that are not traded on public markets.
• Hedge funds: Privately offered funds that can employ a range of strategies – including investing long and short, relative value, global macro and event-driven – and use leverage and derivatives. Hedge fund managers can have a broad range of objectives, from outperformance to low volatility to managing risk.
• Real assets: Direct ownership of property, such as real estate, infrastructure, digital infrastructure, utilities, timberland or farmland.
• Commodities: Physical goods such as gold, oil and agricultural products, or investments tied to their prices.
• Collectibles: Assets such as artwork, cars, antiques, sports memorabilia or rare coins that investors believe will increase in value.

The benefits and considerations of alternative investments

Alternatives can offer potential benefits, but they also come with risks that differ from those of traditional investments. Let’s walk through a few examples.

The benefits

• Diversification: Some alternative investments may perform differently from traditional stocks and bonds, providing another way to diversify a portfolio and potentially reduce concentration risk. Diversification doesn't guarantee against losses, however.
• Return potential: Certain alternatives may provide access to opportunities outside public markets, such as investing in privately held companies. Some investments, including private credit and certain real estate strategies, may also provide income. That said, the potential for higher returns generally comes with additional risks.
• Access to different investments than what’s available in public markets: Alternatives can provide exposure to private companies, physical real estate, commodities and other assets that may not otherwise be represented in a traditional portfolio.

The considerations

• Less liquidity: Money in a private equity or real estate fund (as examples) can be locked up for years, so it isn't the place for cash you might need soon.
• More complexity: Alternative investments can be more complex than traditional investments because pricing, fees, investment structures and rules about when you can sell or access your money may be different from what investors are used to with publicly traded stocks and bonds.
• Higher fees: Some alternative funds charge management or performance-based fees that can reduce returns.
• Less transparency: Certain private investments don't have the same disclosure requirements as publicly traded securities.
• Concentration risk: Alternative investments can involve larger position sizes due to higher minimum subscription amounts and limited investable opportunities. As a result, a single fund, asset or strategy may represent a significant portfolio exposure, increasing the impact of adverse performance in that area on overall portfolio returns.
• May have to be an accredited investor to access some alternative investments: Many alternative investments are limited to investors who are accredited investors, meaning you may need to meet specific financial thresholds (such as income or net worth) or professional qualifications before you can participate at all. That puts some of these opportunities out of reach for investors who haven't yet met those standards, and eligibility rules can vary from one fund to the next. It’s also important to note that some private funds set a higher bar than accredited investor status, so eligibility can vary beyond these requirements, too. A financial professional can help you determine your eligibility.

How to decide if alternative investments are suitable for your portfolio

The right starting point is your own financial picture: how much liquidity you need, your time horizon and risk appetite, and your comfort with complexity. Someone with a long runway before retirement and cash already set aside might have room to lock up part of their portfolio for years in pursuit of potential diversification, income or a higher growth opportunity. Someone who might need that money soon probably shouldn't take the same approach.

It can help to frame any decision in the context of a broader wealth plan – your goals, taxes, estate considerations and cash-flow needs – so the investment supports the bigger picture, not just returns.

Also consider how the investment fits with what you already own. Alternatives are generally incorporated alongside traditional investments rather than used as a replacement for a diversified portfolio.

Most importantly, understand how the investment works: how it could make or lose money, what fees you'll pay, and when you can access your money.

How to get started investing in alternative investments

If you think you’d like to move forward with alternative investments, you’ll want to consider taking the following steps:

1. Educate yourself. Before committing any money, understand how a given investment works, what drives its returns and what could go wrong.

2. Assess accreditation status. Some alternative investments are limited to accredited investors under Securities and Exchange Commission (SEC) rules, and some private funds may impose higher standards. Individuals generally qualify via net worth over $1 million excluding a primary residence (alone or with a spouse or partner); income over $200,000 individually (or $300,000 with a spouse or partner) in each of the prior two years with an expectation of the same this year, certain licenses in good standing (Series 7, 65, or 82), or by professional status. Entities may qualify based on scale or structure or by regulated/financial-entity status.²

3. Research investment vehicles. There may be different ways to gain exposure to an alternative investment, including private funds, interval funds and other investment vehicles. Compare minimum investments, fees, liquidity and other requirements before investing.

4. Emphasize due diligence and asking the right questions. Look into the investment’s track record (if there is one), how the investment is structured, what fees you'll pay and when you can get your money back.

5. Consider working with a financial advisor. An advisor can help you evaluate whether a specific investment fits your broader plan and how much of your portfolio it should represent.

The bottom line

Alternative investments aren't inherently better or worse than traditional stocks and bonds. They're a different set of tools that may provide additional diversification, income or growth opportunities, but they can also come with less liquidity, higher fees and added complexity. Understanding the investment and how it fits with your current portfolio and investment strategy can help you make a more informed decision.