What Sets Wealthy Investors Apart: Alternative Strategies
by Gabriel Lewit
If you’ve ever heard the term alternative investments and wondered what it really means, you’re not alone. In simple terms, these are investments that go beyond traditional stocks, bonds, ETFs, or mutual funds. They include assets such as real estate, private lending, commodities, or even private equity companies, which often perform differently from standard investments in the stock and bond markets.
For many high-net-worth investors, these options provide a means to generate new sources of growth or income while reducing the impact of traditional investments on their overall performance.
However, alternative investments aren’t suitable for everyone. They can involve higher minimums, less liquidity, and more complexity than traditional investments, which is why it’s important to discuss them with a Buffalo Grove financial advisor who understands your goals, circumstances, and tolerance for investment risk.
At SGL Financial, we help clients evaluate these opportunities with the same disciplined approach we bring to all of our recommended investment strategies, focusing on aligning with your long-term goals, comfort with risk exposure, and tax efficiency.
SGL Pro Tip: We know your most significant financial risk is a failure to pursue your long-term financial goals.
So, what exactly constitutes an alternative investment, and why are they becoming more common among investors seeking a more diversified approach to building long-term wealth? Let’s take a closer look.
What Are Alternative Investments?
Alternative investments refer to assets that fall outside the three traditional categories: Stocks, bonds, and cash equivalents (CDs, T-Bills). We recommend them to specific clients because they perform differently from conventional investments; for example, stocks can go down due to increased inflation, and real estate investments can go up. This adds another layer of diversification to your investment strategy.
Frequent examples used by the ultra-wealthy include:
- Private real estate, such as income-producing apartment complexes, office buildings, or real estate funds.
- Private equity or venture capital, investing in companies before they go public.
- Hedge funds and managed futures employ distinct strategies to generate positive returns in a variety of market conditions.
- Commodities and precious metals, including gold, oil, and/or agricultural products.
- Private credit, also known as direct lending, involves investors providing debt financing to businesses.
These types of investments can offer unique opportunities for improved returns, for example, income potential, inflation protection, or exposure to markets not tied to Wall Street forecasts for future returns. But they can also involve higher risk, longer holding periods, and more limited access to your money compared to traditional investments that trade on public exchanges. Because of this, these investments are not for everyone, particularly the traditional investor.
Because of these differences, it’s important to work with a Buffalo Grove financial advisor who can help you understand how (or if) alternative investments fit into your broader strategy and if so, which ones. A fiduciary advisor should take the time to review your financial situation, time horizon, and comfort with risk before recommending any allocation to alternatives.
SGL Pro Tip: A fiduciary advisor is held to the highest ethical standards in the financial service industry. Investor interests always come first.
Check out our new Quick Guide on: “Dealing with Financial Risk: Use Proactive Preservation Wealth Strategies.”
What does it mean when an investment is correlated or uncorrelated to the stock market?
In simple terms, correlation measures how closely two investments move in relation to each other during the same market conditions.
- Highly correlated investments, such as large-cap U.S. stocks and stock mutual funds, tend to move up or down at the same time.
- Uncorrelated or low-correlated investments, like private real estate, commodities, or managed futures, often move differently or even in the opposite direction at the same time.
Why does this matter? Because when all your investments move together, your portfolio can experience sharper ups and downs. By adding uncorrelated assets, you can spread risk across different asset classes that react differently to the same market conditions.
This is one reason why so many financial advisors in Buffalo Grove recommend reviewing whether alternative investment strategies could create additional diversification and improved returns.
Why Do the Ultra-Wealthy Invest in Alternatives?
Wealthier investors often face different challenges than those still just starting the accumulation of wealth, including tax exposure, concentrated stock positions, and the need for alternative investment strategies.
Here are a few reasons why alternative investments appeal to them:
- Diversification of Risk: Traditional portfolios heavily weighted in equities can be more vulnerable during market downturns. Alternatives may offer smoother performance when stocks decline, reducing overall declines in value.
- Potential for Income or Inflation Protection: Real estate and private lending can provide ongoing income streams. Commodities and certain tangible assets like precious metals tend to hold their value better during inflationary periods.
- Access to Unique Investment Opportunities: Private markets sometimes move independently of public markets and can offer increased exposure to higher-growth companies before they go public.
- Tax Efficiency: Some private real estate funds or limited partnerships provide depreciation benefits or tax-advantaged income structures.
SGL Pro Tip: When you have the complexities of investing larger sums of money, you may benefit from a more sophisticated investment strategy.
Are Alternative Investments Right for Everyone?
Not necessarily. Alternatives typically involve higher minimums, limited liquidity, and are based on more complex structures than investing in the public markets (stocks, bonds). They’re best suited for investors who can commit capital for more extended investment time periods and already have a strong core portfolio in place.
That’s why advisors often use a “core-satellite” approach:
- The core of the portfolio holds traditional, diversified stock and bond investments for improved stability and long-term returns.
- The satellite portion allocates a smaller percentage (perhaps 5% to 10%) to alternative investments for additional diversification and potential returns that are higher than core returns.
Before considering any alternative investment strategies we recommend talking to a Buffalo Grove fiduciary financial planner to evaluate whether this type of investment strategy will work for you.
How Do Traditional Investors Access Alternative Investments?
Access was previously limited to institutions and individuals with ultra-high net worths. But that’s changing. Today, many financial advisors in Buffalo Grove work with platforms and private funds that make alternatives more accessible, often through:
- Private real estate investment trusts (REITs)
- Interval funds (which provide periodic liquidity)
- Private credit funds
- Fund-of-funds structures offering diversification across multiple asset classes
What Are Some Popular Examples of Alternative Investments that the Ultra-Wealthy Use?
Let’s look at several common examples and what purpose each might serve in a diversified portfolio. A Buffalo Grove CFP® professional or expert financial advisor can help analyze how each of the alternatives fits into your overall plan, balancing potential rewards with risk, liquidity, and tax considerations.
Private Real Estate: Direct ownership or participation in real estate funds can generate rental income and potential appreciation. Some investors favor commercial or multifamily properties for steady cash flow, while others prefer development projects for increased growth potential. Real estate can also provide a natural hedge against inflation when rents are indexed to inflation.
Private Equity and Venture Capital: These strategies invest in businesses before they are publicly traded. Investors gain exposure to innovation and growth that may not be available through companies that have already gone public. While the risk is higher, so is the potential reward over more extended time periods.
Private Credit: Private credit involves lending directly to businesses outside traditional bank loans. Private credit may offer attractive yields and more consistent income streams, particularly in companies that charge higher interest rates.
Commodities and Natural Resources: Gold, oil, and agricultural commodities can serve as a hedge against rising inflation or weakening currencies. Some investors use exchange-traded funds (ETFs) or managed futures strategies to access these markets more efficiently.
Hedge Funds and Managed Futures: These strategies aim to generate returns from market inefficiencies, often employing derivatives, leverage, or short-selling. They require due diligence but can offer non-correlated performance relative to traditional markets.
SGL Pro Tip: Diversification is the primary strategy for managing overall investment risk.
Listen to our podcast on: How Smart Planning Beats Bad Luck.”
What Are the Risks of Alternative Investments?
Every investment carries some level of risk, but alternative investments come with their own unique considerations. One of the most common issues is illiquidity, meaning your money may be tied up for several years before you can access it. This makes alternatives better suited for investors who want a long-term investment strategy and don’t need immediate access to their funds.
Another factor is complexity. Many private investments use structures that aren’t as straightforward as publicly traded stocks or mutual funds. Their valuation methods can vary, and reporting may be less frequent or transparent. Because of this, it’s essential to fully understand how an investment works before committing to it.
Costs can also differ from traditional investments. Some alternative funds include management fees or performance-based fees that can impact overall net returns. Additionally, regulatory oversight may be less stringent for specific private offerings, requiring investors to review all offering documents and disclosures more carefully.
Given these factors, it’s wise to discuss any potential alternative investments with fiduciary financial advisors in Buffalo Grove. They can help determine whether the risks and time horizon align with your broader financial plan and comfort level.
How Do Alternative Investments Fit into Tax Planning?
Tax implications vary widely. Real estate may offer current depreciation benefits, while private equity might defer gains until there is an exit event. Specific strategies, like qualified opportunity zone investments, can even delay or reduce capital gains taxes.
At SGL Financial, we coordinate investment decisions with tax-aware planning. By working with your CPA and other professionals, we help align your investment and tax strategies to ensure they work together more efficiently. Connect with us to learn more about alternative investment strategies.
