April 1, 2020
Because of all the volatility in the stock market recently due to the coronavirus outbreak, there has been a lot of interest in alternative investments.
These are investments whose values generally do not correlate with the stock market, with many also offering the potential of long-term gains that even exceed what you can typically earn through stocks.
But, with so many alternative investments out there, how do you know which ones to choose?
While some alternative investments are new and untried, such as cryptocurrencies, others, like investing in art, are highly speculative. But there are 3 types of alternative investments that have objective quality and have stood the test of time. In this article, we will detail these, describing both their pros and cons and the types of returns that you can expect to receive from them.
According to research conducted by Coldwell Banker Richard Ellis (CBRE), multifamily real estate, from 1992 to 2017, generated an average annual return of 9.75%. This is the highest of all commercial real estate investments, and the reason for it is simple: unlike other types of commercial property, people need housing regardless of the prevailing economic situation.
Interestingly, average annual returns from multifamily real estate are almost identical to average annual returns from the S&P 500 over the past century.
But there is one key difference between the two. While the volatility on returns from multifamily real estate is 7.75%, the volatility on returns from the S&P 500 is 19.7%.
Stock investing has on average more than twice the amount of sharp rises and falls than multifamily real estate. So, it is less dependable.
Traditionally, however, there have been a number of major drawbacks to investing in multifamily real estate in comparison to stocks. While you can invest in stocks with a small amount of money, investing in multifamily real estate in the past required you to invest a significant sum of money for a long period of time. Also, owning stock is a passive activity. It requires little or no ongoing effort from you. But owning a multifamily property required you to become a landlord, making you responsible for such things as screening tenants, maintaining and improving sites and dealing with evictions. So, investing in multifamily real estate was often a full-time job.
But this is not the case anymore.
With private real estate investment trusts (REITs), such as those offered by DiversyFund, you can invest in a SEC-qualified fund that does all the heavy-lifting for you, including managing the properties. With as little as $500, you can invest in multifamily real estate as easily and as passively as you can in stocks.
Private equity and venture capital are both forms of alternative investment in which you invest in a business at some time prior to either their sale or the initiation of a public offering. This type of investing can be very lucrative, as it can get you on the ground floor of a company that could very well become the next Google or Facebook.
While the terms “private equity” and “venture capital” are often used interchangeably, there are differences between the two. In general, while venture capital firms invest in early-stage startups, taking a minority stake in them, private equity firms usually invest in more mature businesses in exchange for a majority interest.
According to a study conducted by AQR Capital Management, from 1986 to 2017, private equity has generated returns of 9.9%, which is similar to that of multifamily real estate. It also has a volatility rate of 9.3%, which is only slightly higher than multifamily real estate. This means that it, too, generally provides stable returns.
As for venture capital, Cambridge Associates has found that, in a 30-year period ending in 2017, venture capital firms have generated an impressive 19.07% annual return. Though, while Cambridge does not include annualized volatility rates in its statistics, in the last 30 years the annual volatility rate was never lower than multifamily real estate, and in one year it was as high as 102.03%.
In spite of their high returns, these types of investments are not for everyone. To make them, the SEC generally requires you to be what is called an accredited investor. This means that you must meet at least one of the following conditions:
Clearly, this leaves out most people.
Gold is perhaps the oldest alternative investment. Since the beginning of civilization, people have been using it as a means of storing value that will hold this value at all times, including during war and strife. Two big factors work in its favor: the inherent scarcity of it and the way people universally value it.
But while gold can be a good hedge against market volatility (at the time of this writing, it has risen 6.68% since the beginning of the year in response to the coronavirus crisis), it is not a great means for generating large long-term gains. Over the past 30 years, the value of gold has increased 280%, for an annualized return of a modest 4.55%.
Gold also has another major drawback. It only earns you money when you sell it. It produces no income while you own it. Like stocks, it can be highly volatile, too. Over the past 20 years, its average annual volatility has been at 15.8%, which is twice as high as multifamily real estate.
While many alternative investments promise high returns uncorrelated to the stock market, few have proven to provide these returns consistently in the long-term. Not only has multifamily real estate done this, but with REITs like those offered by DiversyFund, almost anyone today can invest in them as easily as they can in stocks.