Alternative investments have skyrocketed in popularity over the last decade. And there’s no slowing them down. By 2023, assets allocated to alternatives are expected to reach well into the trillions of dollars. For those not familiar, alternative investments are investments that extend beyond things like public stocks, index funds, bonds, and cash. Since 2008, low interest rates have driven investors to explore such alternatives to enhance returns, diversify portfolios, protect against market fluxes, generate income, and combat inflation. The most common types of alternatives have traditionally been private equity, private real estate, private loans, private infrastructure, venture capital, and hedge funds. But these days, alternatives extend to collectibles, farmland, music royalties, art, wine, classic cars, and crypto. But given their unique complexities and high entrance minimums, alternative investments have typically been reserved for sophisticated investors like pension funds and the wealthy. The good news is that new technology and updated regulations have led to a wave of fintech companies entering the space to democratize access. If you want to broaden your portfolio and explore additional passive income streams to help you achieve that elusive FIRE (financial independence, retire early), there’s never been a more exciting time to explore this space.
Before you invest, know the risks
While investing in alternatives can be beneficial, doing so carries several unique risks.
Asset pricing/valuation transparency
Since alternative investments tend not to trade on public exchanges like stocks and index funds, they can carry significant risk related to pricing/valuation transparency. This is because most of the assets that fall under the alternative investment umbrella tend to be valued less frequently, requiring the expertise of dedicated valuation professionals. This is quite different than the daily price discovery you get from the stock market.
Liquidity
If you wanted to sell one of your stocks today, all you’d need to do is press a button inside your brokerage account — and you’d sell that stock at the price displayed on your screen at the time of selling. This is called “liquidity.” Alternative investments, in general, are not considered liquid because they cannot be bought and sold quickly. This results in increased risk if you need to get your money out fast. If you are investing in this space, make sure you can stick with it for the long term. Read more: Emergency funds: everything you need to know
High fees and costs
In 2019, revenues generated from alternative investment products totaled 46% of all investment management industry revenues, according to the Boston Consulting Group — despite representing only 16% of total industry assets. Alternatives tend to be far more costly than traditional investments due to higher management fees and performance fees that are paid to managers to incentivize performance.
Survivorship bias
Lastly, it can be difficult to judge some types of alternatives’ accurate long-term performance track record due to “survivorship bias.” This is when too much weight on an investment type’s performance is attributed to big winners — while the losers aren’t considered. Investments that suffer from survivorship bias can give investors a false sense of how good that type of investment actually is. The mutual fund and hedge fund industries suffer immensely from this bias.
3 alternative investment options for earning passive income
If you’ve done your homework and are comfortable with the risks, here are a few cool areas to explore:
Real estate
Real estate is a well-known and broadly adopted means for building wealth. According to Knight Frank’s 2021 wealth report, real estate made up ~20% of ultra-high-net-worth individuals’ portfolios in the U.S. Since investing in real estate comes with substantial upfront costs and ongoing responsibilities, many private real estate crowdfunding platforms have emerged to help individuals benefit from real estate while being hands-off. Fundrise, Yieldstreet, and Groundfloor all offer different types of private real estate investment opportunities that are accessible to everyday investors. Using one of these platforms allows you to get exposure to income-generating properties or high-interest real estate-backed loans. Since each platform is different, make sure you compare their respective offerings. You can also access income-producing real estate assets through publicly traded real estate investment trusts (REITs) but be wary that they will be subject to the daily ups and downs of the market. Read more: Investing in REITs: everything you need to know
Music royalties
When an artist records a song, copyrights are created that generate revenue every time it’s played. With music industry revenues topping $40 billion in 2021, investors have been looking to music royalties to generate predictable income that’s not impacted by the economy. Music royalty investments first gained notoriety in 1997, when David Bowie used the income stream from his royalties to raise $55 million at a 7.9% annualized return. Dubbed “Bowie Bonds,” they enticed investors with passive income generated by Bowie’s music. These assets are seen as a supplement for certain types of bonds or, in industry terms, “asset-backed securities.” Major investment firms like BlackRock, Blackstone, and KKR have recently formed partnerships to invest in music royalties. Many prolific musicians like Bob Dylan, Neil Young, Fleetwood Mac, and others begin to sell their catalogs. Other players in this space include Hipgnosis Songs Fund and Round Hill Music Royalty, who similarly buy music royalties and distribute the income generated to shareholders as dividends. If you are as interested in this space as I am, check out platforms like Royalty Exchange or Songvest that let you either directly purchase music royalty IP or fractional shares of royalties. You can also explore the publicly listed shares of Hipgnosis or Round Hill, both of which are listed on the London Stock Exchange. But note that since there are many types of music royalties that carry significantly different values, this isn’t a space to get into if you aren’t willing to do the research.
Farmland
Farmland is one of the most important resources out there, but one that many seem to forget about. Due to its importance and scarcity, farmland has been one of the best performing investments, beating out U.S equities from 1992 to 2020. And with rising demand and shrinking supply, it’s not unreasonable to expect farmland will continue to perform strongly. Unfortunately, most farmland investment opportunities are still reserved for accredited investors, including those offered by crowdfunding platforms like Acretrader and Farm Together. But some options don’t require you to be an accredited investor. Agriculture lending platform Steward and some offerings from Harvest Returns are examples. You can also explore farmland Real Estate Investment Trusts (REITs) like Gladstone Land Corporation and Farmland Partners. Like other REITs, though, they will be subject to daily price fluctuations.
The bottom line
If you’re starting your own FIRE journey (or already well on your way), the stock market has probably been your primary investing playground. But if you’re looking for alternative investments to keep that passive income flowing (and you know your risk tolerance), then non-traditional options like real estate, music royalties, and farmland could be worth considering. Featured image: KT Stock photos/Shutterstock.com
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