One of the most intimidating factors that puts people off arranging their financial affairs for retirement is how vast the investment world is. There are simply so many different ways and places to save or invest money so that it (hopefully) grows. Take the stock market, for instance. Which stock market do you invest in? Do you invest in several? Or just a handful of companies - and what ones should they be?
One exceptionally vast asset class is the alternative investment market. Yet, ignoring it because it is so enormous can mean that you miss out on some fantastic benefits that it has to offer. Knowing what alternative investments are out there could improve your returns if you are thinking about ways to bolster your pension pot.
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What are alternative investments?
The alternative investment market is so vast because there are so many types of them - making them hard to define concisely. It is perhaps easier to say that an alternative investment is anything that is not a stock, a bond or cash. A list of alternative investments would usually include:
- Fine wine
- Real estate investment trusts or REITs
- Venture capital
- Private equity
- Classic cars
The list can go on and on. But what even the brief list above does show is how diverse the range of assets classed as alternatives are.
Even within the above asset classes, there is a massive amount of diversity. Commodities or derivatives are good examples as they both offer a vast breadth of what can be bought and sold to increase wealth. Obvious commodities would be oil, gas and precious metals. Yet, sugar, soy and corn are all commodities too.
Other alternative investments that can also provide a good return on investment would be art and antiques, cars, wine and property. These are all bought and sold privately. In fact, property can be an asset class many people invest in without knowing they are dabbling in the alternative investment market.
Ultimately, what all these diverse examples go to show, is that an alternative investment is not:
- A fixed income financial instrument
- A share in a company
- Holding cash in a short term savings account
Instead, it is an asset that people buy with the hope that it will increase or retain its value. However, like all investments, alternative assets have the potential to fall in value and increase.
Why are alternative investments an excellent addition to a portfolio?
When it comes to mitigating against risk, you may want to consider adding some alternative investments to your portfolio. Even if you are nearing retirement day, holding some alternative assets is still a strategy many pension fund managers follow. The reason being is that alternative investments add significant diversification to a pension pot. Alternatives move in different ways to other financial instruments and markets as many are not as beholden to outside factors like Governments, Government policy, or other factors that directly impact stock markets. That weak correlation can help protect against losses and minimise them.
Essentially, by investing in alternative assets in addition to more traditional classes like stocks and bonds, you are lessening your exposure to just one investment. It is practising the art of not putting all your eggs in one basket. Even if you have many different shareholdings in a broad range of companies, those companies are still influenced by many of the same market factors. In short, if the stock market has a broadly lousy day, it is hard to stay immune to those losses, even if you think you had initially only chosen fantastic, too good to fail companies.
Additionally, many alternative investments can experience less volatility than stock markets. While past performance is never a predictor of future performance, it is true to say that historically speaking, some alternative assets are not prone to the amount of volatility that stock markets are.
Potential income stream
One significant advantage of some alternative investments is the income stream they can generate. That’s a big plus for anyone trying to grow their wealth at the best of times. However, if you retire or your salary has stopped, having an income stream you can rely on is vital. While pension funds will often start paying out an income to you when you start drawing your pension, alternatives can also offer a secondary income stream. Property rental payments are an excellent example of that - in a way that dividends from stocks cannot often match.
Potential for higher returns
Plus, finally, alternative assets can offer the chance to generate higher returns than stocks or bonds. If the higher returns were not there, investors would not be tempted to deviate from stocks and bonds. Higher returns are what are expected and necessary to take on the additional risks that alternatives pose.
What are the disadvantages of alternative investments?
For starters, alternative investments are traded in an unregulated way. Stock markets and bonds are regulated, which provides investors with some form of protection in a way buying a fine wine from a wine dealer never could. Regulation has its obvious benefits of safety and security - not least that it stops the stock market from slipping into the black market territory or anywhere near it. And, in doing so, it ensures that the stock market is a fully working vehicle. As a result, liquidity remains.
Liquidity is a massive benefit of the stock and bond markets that alternatives can lack. Liquidity is a significant advantage when it comes to trading as it means that you can be almost certain that you will be able to sell an asset. That’s a massive comfort as an investor. On the other hand, not being able to sell an asset is highly restrictive and means that you cannot get your hands on cash when you need it. If you are nearing retirement, that is something to be very aware of as your situation may require you to need cash at short notice. That is the case for people who do not have a steady income or even those not nearing retirement but no longer have a salary.
Property is an excellent example of how illiquid alternative assets can be. Selling a house or property can take a long time - yet it often holds so much value. That is a considerable risk to take should you rely on the cash tied up in that property. But, of course, the benefits are enjoying a rental income and (often) an appreciation in value.
Risk of losses
Finally, while alternative investments are not always particularly volatile and not strongly correlated to stock markets, they can suffer significant losses. For example, take the oil market at the beginning of 2020. The pandemic had a considerable impact on oil prices which hit previously unimaginable lows.
Are the disadvantages of alternative investments worth the risk?
If you are at a point where you are closing in on drawing from a pension pot, that pension pot must retain as much of its value as possible. For that reason, it may be best to look at the less risky alternative investments or the ones that have historically held their value better.
And, additionally, you must take into account any issues with illiquidity mentioned above. For example, if you have a painting or antique you have invested in, there might not be many potential buyers. Therefore, getting the right price for your asset requires the time to sell it to the right investor. That investor may take a while to come along. Yet, you may need those funds more quickly than that.
That being said, you may feel that not being able to sell an asset is acceptable when balanced against some of the benefits of alternatives. The fact that an alternative investment may not lose much value, as a stock could do, is an immense comfort for some. It could be that you are happy to take on that additional risk due to the potential return that you could generate from investing more heavily in alternatives. Plus, you may like that some alternatives do not usually have as much volatility as traditional stocks are prone to. That’s a significant benefit if your investment timeline is coming to an end.
Need to know facts about the alternative investment market
The alternatives investment market is a vast beast to get to grips with. For example, there is so much choice on offer in the commodities field alone that it can become overwhelming. For that reason, you may find that investing in funds that have been diversified already with alternatives is a good option so that you get exposure to alternatives without worrying about a lack of knowledge.
That being said, alternatives can also offer an excellent opportunity to put specialised knowledge to good use. If you like cars, some cars can provide attractive investment potential if you know what you are investing in. The same can be said of property, jewellery or antiques. As you know and understand what you are buying, you are more likely to see when you have a good deal or at least an asset that has the potential to retain its value or not - which is a fundamental need for many retirees.