Investors are increasingly turning to alternative investing to supplement the lackluster performance of fixed-income securities and find greater returns than equities. With little or no correlation to other assets, alternative investing also provides diversification in a portfolio since it doesn’t always move in tandem with the stock or bond markets.
However there’s a lack of transparency and risk in alternative investments like private equity and hedge funds. Because of these risks, alternative investments are generally limited to institutional investors, endowments or accredited investors who have earned $200,000 annually for the two most recent years or have at least $1 million in equity excluding the value of their home.
For investors who don’t qualify under that criteria, there’s still a good number of alternative investing options available to them that fit different goals and risk tolerance. As always, investors should understand the risks involved and be aware of taxes, restrictions and fees.
Low-cost REIT Index Funds
A real estate investment trust (REIT) makes money by receiving rental income from hotels, office buildings, malls and other real estate properties in their holdings. By law, they are required to pass 90% of this income to investors in the form of dividends that can provide a nice cash flow and serve as a hedge against inflation and rising interest rates.
While REITs can have nicer yields than bonds, they’re also riskier. To get started in investing in REITS, investors should consider a low-cost REIT index fund, which in turn invests in REITs. Investors can choose a fund that seeks growth or a fund that invests in the broad REIT universe. To get started, you can sign up online for one of NerdWallet’s recommended brokerage accounts offering access to a variety of index funds and ETFs here. The average investor should not invest in a REIT that isn’t publicly traded as they can be illiquid and lack transparency.
Commodities add a different flavor to a portfolio as they behave differently than stocks and bonds as a limited resource. Commodities have increasingly grown popular with investors who want to add diversification to their portfolios and take advantage of the exposure between demand and a limited supply of a tangible asset such as energy, agriculture, precious metals and livestock.
A common way to invest in commodities is to trade futures or options on them but speculative trading can lead to huge losses. Investors who don’t have the know-how or the time to play on the exposure of supply and demand can invest in commodity-based ETFs which are physically backed by a commodity or based on commodity futures. The ideal type that an investor chooses will depend on the tolerance for risk and paying fees. Investors will also have to choose between ETFs that track the performance of a broad basket of commodities or a specific commodity class and this will largely depend on the type of exposure they’re willing to take.
Investors who want to find regular income payments in a down economy can be a lender in a peer-to-peer loan such as The Lending Club or Prosper. Borrowers apply for a loan and are carefully screened. Lenders can then choose a loan to finance or set criteria such as the length of the loan or a borrower’s credit rating and then have their money invested accordingly.
By connecting lenders and borrowers directly to each other, these peer lending companies can offer better rates for borrowers and provide regular monthly income payments for lenders. However investors should always be aware that borrowers can default on their loans.
Equity crowdfunding will be a new way for average investors to invest in startups in exchange for shares. Previously this was only available to accredited investors but now the proposed rules for equity crowdfunding would allow those who make less than $100,000 per year to invest $2,000 or 5% of their annual salary into a startup, and those who make more than that can invest 10% of their annual income into a startup. Startups would not be allowed to raise more than $1 million per year.
While equity crowdfunding allows investors to capitalize on a company pre-IPO, investors should remember the risks of owning an unproven company. Most startups fail and investors will simply lose their money. Even if a company goes public, there are complex regulations and waiting periods for selling restricted shares. Still, if investors are buying stake in strong companies like Twitter or Facebook, equity crowdfunding can be an alternative investment with great returns.
Impact Investing refers to the investment in companies or funds that aim to generate returns as well as a positive social, economic or environmental change although that’s not always an easy combination. Impact investing, or socially responsible investing, can include microfinancing, social impact bonds or private equity funds that aim to alleviate a number of issues from providing clean water in developing countries to reducing homelessness.
Impact investing was typically limited to individuals with high net worth, but now investment management companies and brokerages have leveraged the playing field by allowing smaller investors to buy short-term notes that lend principal to different communities and causes.
One popular brokerage platform for impact investing is MicroPlace. Notes at MicroPlace mature anywhere from three months to five years and can earn a 0.5% to 4.5% return. These notes are not guaranteed by the FDIC and investors should be aware of inherent risks by reading the prospectus provided by issuers.
Hannah Kim is a financial writer at NerdWallet, a site dedicated to helping consumers learn how to manage their money, whether it’s to help them find the best credit cards for their needs or find the best car insurance.