Alternative Investments Are Gaining Popularity

20 January 2025

Stocks and bonds, longtime centerpieces of many Americans' investment portfolios, appear to be losing popularity with some people. A 2024 Bank of America survey found that nearly three-quarters of respondents ages 21 to 43 doubt they can achieve above-average returns by investing solely in traditional stocks and bonds. In comparison, only 28% of investors over age 44 reported feeling this way.

Which investments do younger respondents believe have the greatest opportunity for growth? The following results might surprise you:

• Stocks (14%),
• Bonds (17%),
• Real estate (31%),
• Cryptocurrency/digital assets (28%), and
• Private equity (26%).

Those responses signal a shift among Millennials and Generation Z investors from stocks and bonds to alternative assets, such as real property, crypto assets and private equity. While such investments may offer potential advantages over marketable securities, they also come with some important downsides and risks. Here's what you should know before investing your hard-earned money in these nontraditional assets.

Real Estate

The old saying, "Buy land; they're not making it anymore," rings true for many investors. With a rental property, you receive a steady income stream while you own it, plus a healthy gain when it's sold if the property has appreciated in value. Vacant land and other properties that don't generate rental income may still generate significant gains over time.

Compared to stocks, real estate is a tangible asset that you can control. While a stock investor typically can't affect the decisions a public company's management team makes, a real estate investor can increase a property's value by, for example, renovating or making smaller improvements.

Real estate has some tax advantages over stocks, too. You can defer capital gains taxes on real property sales through installment sales or Section 1031 like-kind exchanges. You also may qualify for deductions for depreciation, mortgage interest, property taxes and other expenses. Although rental income is taxed as ordinary income, you might be eligible for additional tax benefits depending on your level of involvement in the rental activities.

Real estate is also appealing because you can use debt to buy it and then refinance the loan to obtain cash for other investments. And it's widely regarded as a hedge against inflation because rent generally rises along with other prices. However, inflation and economic downturns can lead to vacancies, costly evictions and plunging property values. Because of real estate's illiquidity, investors can't quickly sell it to help them deal with financial crunches.

Further, real estate requires a substantial investment of time and money. You must research to find appropriate properties, come up with a down payment and pay closing costs. If the property is a rental, you'll have to deal with tenants and take care of repairs and maintenance — or pay for a property manager.

Cryptocurrencies/Digital Assets

The Bank of America survey found that almost half of the younger high-net-worth investors own cryptocurrencies, and another 38% are interested in owning them. Crypto's decentralized nature and streamlined, transparent transactions are major draws.

Investors may also be drawn to the dramatic price surges that periodically make headlines. But those surges reflect the extreme price volatility. Moreover, big jumps in the value of digital assets aren't backed by any real asset or driven by an operating company's performance or prospects. In fact, they're frequently the result of unpredictable drivers, such as social media postings, which makes prices vulnerable to market manipulation.

Plus, cryptocurrencies also generate negative headlines for hacks and scams, technical glitches, collapsing currency exchanges, and absconding founders. Crypto investors have few protections, and the regulatory and tax environments remain uncertain.

It's also worth noting that blockchain technology, the foundation of crypto, has existed for 15 years and still hasn't caught on widely, raising questions about crypto's long-term prospects. This technology leaves behind a significant carbon footprint that eco-conscious investors should consider, too.

Private Equity

Private equity generally refers to investing capital in private businesses or taking public companies private, typically those identified as having high growth potential. Private equity investors can access investment opportunities not otherwise available. These may include start-ups or companies executing major strategic transformations. Such companies can grow without the short-term pressure of stock market expectations, and the returns can be significant.

Investors also may benefit from tax incentives for investing in qualified small business stock (QSBS). Eligible investors can exclude a healthy portion of their gains from selling QSBS.

But private equity has a high barrier to entry — the minimum investment can run into the millions of dollars. With no guarantee that acquired companies will succeed, investors must accept the risk of hefty losses if an acquisition fails.

Private equity investments also bring steep management and performance fees, which reduce investors' returns. Private equity firms usually use debt to make acquisitions, and debt service can further erode returns.

Bear in mind, too, that private equity investments are illiquid. Investors are generally expected to leave their investments in a private equity firm for five to 10 years, if not longer, before seeing their returns. In short, private equity offers substantial potential upside but comes with significant risks that might not appeal to risk-averse investors.

Look Before You Leap

Due diligence is critical for investors considering these alternatives. Understanding the associated risks, required time commitments, tax implications and potential for losses is essential to making informed decisions. Before taking the plunge, consult a financial advisor to ensure any investment you're considering aligns with your goals, risk tolerance and overall financial strategy.

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