Alternatives

As indicated in the overview to Types of Investments, there are alternative asset classes beyond the so-called core asset types. Alternatives include both physical assets and ways of investing. The alternatives can really be divided into three groups:

  1. Real estate
  2. Collectibles
  3. Everything else

The average person may own real estate and a number of collectibles. While they may consider these assets as investments, many investors also have a very personal attachment and emotional reason to own them. Such is not the case for most of the other alternatives (such as, commodities, derivatives, hedge funds and private equity). These are the high risk and potentially high returning investments. Many are speculative. Even the terminology is different:

  • Gambling
  • Betting
  • Trading

In the world of investing, these speculative types of alternatives are best left to the experts to execute and to investors who can “afford” to lose their entire investment. In fact, the minimum investment amounts may be so high that most people simply can’t afford them.

Government regulation may also decree certain investments to be of such high risk that investors need to qualify as accredited investors before being allowed to purchase them. That said, there may be opportunities through investment funds to enjoy a percentage participation in certain alternatives.

Alternatives and the Taxman

Generally any profits or losses realized at disposition are treated as capital gains/losses. Income distributions will be subject to tax and the type of income depends on the investment. In addition:

  • Principal residence proceeds are not subject to tax.
  • For rental real estate, rental income (after expenses) is taxable.
  • Collectibles may be treated in one of two ways:
    • Profits on sales of personal items are treated as capital gains UNLESS the buy and sell prices are both under $1,000.
    • For listed personal property, which is personal-use property that is expected to increase in value over time (such as, coins or art), capital losses can be applied to reduce gains only from other listed personal property.

Descriptions of various types of alternative investment instruments available are shown below.

Alternative Investments

Features

Real estate investments*

(such as a principal residence, recreation property or rental real estate)

*For more on real estate see the More section below.

 

 

  • Considered by many to be a good hedge against inflation
  • Offer capital gains potential
  • May produce rental income
  • Most require management time
  • Prices can fluctuate greatly
  • May take several months to turn investment into cash
  • Need to be researched carefully
  • Caution is advised

Collectibles (such as antiques, art, rare coins, and stamps)

  • You own the asset outright
  • No income
  • Considered luxury goods, so price and demand fluctuate with the economy
  • Not very liquid; investors have to find a willing buyer
  • Personal attachment and emotional ties add a layer of complexity to the investment

Infrastructure

  • Considered a defensive asset: steady returns and lower price volatility than equities
  • Long investment life
  • May specialize (such as, transportation, hydro, telecommunications)
  • High-cost entry point: most investors have access through an investment fund

Gold

  • Considered by many to be a good hedge against inflation
  • Offers the potential of capital gains or losses.
  • No income
  • Prices fluctuate daily
  • Borders on being a speculative investment.
  • Caution is advised

Options and futures

  • Formal contracts grant the holder the right to purchase a certain investment at a fixed price over a predetermined period of time
  • Investor pays a premium that fluctuates with the price of the underlying investment
  • Highly speculative, complex and risky
  • Large amounts of money can be quickly lost or gained
  • Should be avoided by novices and those with limited financial resource

Hedge funds

  • A fund that uses derivatives and borrowed money (leverage)
  • While hedging may be used to reduce risk, optimizing returns is the driver for many funds
  • Fund managers use one or more strategies attempting to achieve an abnormally high rate of return
  • May do well when equity markets are going through periods of volatility
  • Fees are high: both an ongoing management fee plus a high performance fee whenever a positive return occurs