Why You Should Consider Alternative Investments for Retirement
Retirement is supposed to be the golden years when you get to relax and enjoy the fruits of your labor. However, more retirees nowadays struggle to generate enough income from traditional retirement vehicles like Social Security and savings accounts. This has created a retirement income crisis that requires thinking outside the box.
That’s where alternative investments for retirement income come in. Far from just stocks and bonds, alternatives like real estate, peer-to-peer lending, and commodities can provide portfolio diversification, higher yields, inflation protection, and passive income potential.
This guide will explore the most popular alternative investments to consider for retirement, tips to get started, and step-by-step due diligence to ensure you make informed decisions.
Check Out: The 12 Best Clean Energy Stocks to Fuel Your Portfolio in 2024
Key Takeaways
- Alternatives like real estate and P2P lending can supplement retirement income.
- They also reduce overall portfolio risk through diversification.
- Start small with 5-10% of your portfolio.
- Vet each investment thoroughly and understand the risks.
- Work with a financial advisor to determine suitability.
Common Alternative Investment Options
There is a vast universe of alternative investments to consider beyond the usual stocks, bonds, mutual funds, and certificates of deposit that make up most retirement portfolios. Here are some of the most popular.
Real Estate
Real estate rentals can throw off ongoing passive income that lasts through retirement. You can invest directly in rental properties or real estate crowdfunding and REITs. The key advantages here are portfolio diversification, cash flow, inflation hedging, and historically solid returns.
Check Out: Zero to Hero: Your Essential Guide to Alternative Investing as a Beginner
Peer-to-Peer Lending
P2P platforms let you lend money to borrowers and earn interest. Returns typically range from 5-12% which beats savings accounts and bonds. It offers a fixed regular income with minimum effort. However, you do take on default risk. Stick to proven platforms to mitigate this.
Annuities
While complex, annuities allow you to convert retirement savings into guaranteed lifetime fixed income so you don’t run out. Fixed, indexed, and variable annuities with living benefits help hedge uncertainty and provide peace of mind. However high fees and opaque terms can be drawbacks.
Commodities
Commodities like gold, silver, and oil serve as an inflation hedge and diversifier from financial assets. Gold, in particular, has intrinsic value worldwide. Gain exposure via stocks, mutual funds, ETFs, etc. rather than direct ownership which has storage/liquidity issues. Annual returns average 5-10%.
Artwork/Collectibles
Items like fine art, wine, antiques, coins, etc that may be appreciated over decades can offer diversification plus psychological returns from owning tangible assets. Returns are unpredictable but often beat inflation long term. Ensure proper appraisal, authentication, insurance, and storage.
Cryptocurrencies
Crypto like Bitcoin and Ether have earned stunning returns recently but carry huge risks due to extreme volatility. Yet the blockchain technology, decentralization, and inflation resistance they introduce could be game-changing. A 1-5% crypto portfolio allocation makes sense for aggressive investors.
Non-Traded REITs
These real estate investment trusts don’t trade publicly like stocks so they avoid market gyrations. While illiquid, they provide steady dividends averaging 6-8% from the underlying property investments. REITs offer passive real estate diversification without the hassles of owning property directly.
Oil and Gas Partnerships
Oil/gas partnerships let investors buy ownership stakes in new wells. Income comes from sale proceeds and drilling royalties. The upside is fat yields averaging 10%. However significant tax paperwork and the risk of hitting empty wells are downsides. Still, diversification into oil/gas production is attractive.
| Alternative Investment | 10-Year Average Annual Return |
|---|---|
| REITs | 9.32% |
| Gold | 8.81% |
| P2P Lending | 5.97% |
| Art & Collectibles | 13.29% |
| Bitcoin | 230% |
Benefits of Alternative Investments for Retirement
Adding alternatives alongside mainstream assets like stocks and bonds can provide these advantages specifically helpful for retirees:
- Diversification beyond stocks/bonds – Alts like real estate operate under a different set of market factors allowing you to reduce overall portfolio risk/volatility during market uncertainty.
- Higher yields than bonds/CDs – Bonds and CDs currently yield almost nothing after inflation. Options like P2P lending, REITs, and commodities frequently generate yields 5-10% higher.
- Passive income potential – Certain alternatives like rental property, P2P lending, annuities, and royalties from oil/gas partnerships can provide ongoing passive income. This gives peace of mind knowing part of retirement spending is covered.
- Inflation protection – Real estate, gold, silver, artwork, and some annuities maintain or increase purchasing power over long periods so they beat inflation. This helps ensure your money doesn’t run out too fast.
- Reduce overall portfolio risk – All investors need portfolio hedges to smooth volatility and mitigate sequence return risk in retirement. Adding alternatives substantially reduces overall portfolio risk compared to only holding stocks and bonds.
Check Out: 9 Best Alternative Investments for Business Growth in 2024
Tips for Getting Started with Alternative Investments
Jumping into alternatives can get complex fast, so go slow and tread carefully.
- Start small/don’t go all in – Allocate only 5-10% of your total portfolio to alternatives to start. See how you handle the added complexity before increasing exposure.
- Vet investments thoroughly – Do your due diligence! Make sure you understand each investment and its risks before committing substantial capital.
- Work with a financial advisor – A qualified retirement planning advisor can help determine if specific alternatives suit your needs and risk tolerance. Leverage their expertise.
- Understand risks like volatility, and illiquidity – Many alts come with higher volatility, lack of liquidity to cash out fast, opaque tax implications, etc. Consider risks versus your timeline and goals.
- Focus on 5-10% of the portfolio – Even pioneers of alternative investing recommend limiting exposure to 5-10% to start. Quality stocks and bonds should still form the core holdings.
| Alternative | Liquidity Timeframe | Restrictions |
|---|---|---|
| Publicly Traded REITs | Intraday to <1 week | Market volatility may delay trades |
| Rental Properties | 1-6 months typical | High sale costs, finding buyers |
| Annuities | 5-10+ years | Substantial early withdrawal penalties |
| Gold ETFs | Intraday to <1 week | Market volatility may delay trades |
| Art & Collectibles | > 1 year | Authentication, specialized buyers |
Due Diligence Steps Before Investing
You can’t be too careful when evaluating alternative retirement investments. Follow these key due diligence steps:
- Cash flow analysis – Projected returns mean nothing without understanding cash flow expectations from costs, taxes, inflation, etc. Get clarity on net cash flow.
- Track record – Look for a multi-year history of steady verified returns. Beware of new unproven investments with short or confusing track records.
Management expertise – Ensure the executives or fund managers have decades of direct experience specifically with this type of alternative, not just general investing.
- Investment structure/terms – Vet the investment prospectus or contract completely. Watch for red flags like overly complex legal terms, short lockup periods, lots of fees, or lack of transparency.
- Tax considerations – Understand the short and long-term tax implications so you don’t get surprised later by unexpected taxation.
- Fees involved – Some complexes like annuities and specialized ETFs carry layers of hidden fees adding up to over 5% annually. Compare fees to other products.
| Alternative | Taxation |
|---|---|
| REITs | Dividends taxed as ordinary income |
| P2P Lending | Interest taxed as ordinary income |
| Art & Collectibles | Capital gains tax after sale based on appreciation |
| Bitcoin | Taxed as property similar to stocks |
| Annuities | A tax-deferred vehicle with delayed taxation |
Which Alternative is Right for You?
With many flavors of alternatives available, narrowing down the right match requires some soul-searching about your specific situation and objectives:
- Match investment goals – Are you focused on portfolio diversification, inflation hedging, or maximizing passive income? Not all alternatives serve every purpose.
- Consider timeline – Simple options like dividend stocks may work better for near-term income versus long-term plays like fine art that require decades to appreciate.
- Factor in risk tolerance – If you lose sleep over volatility, risky picks like crypto, commodities, and speculative real estate may not fit your temperament, despite upside potential.
- Account for income needs – If reliable monthly cash flow is critical, target alternatives structured for steady income like rental property, P2P lending, annuities, or REITs.
- Be realistic – Take a critical look in the mirror. Do you have the expertise and bandwidth as a retiree to directly invest in complex assets like rental property or oil wells? Leverage access via funds if direct investment is impractical.
Alternatives Specifically for Retirement Income
While all alternatives serve a diversification purpose, these options have structures particularly well-suited to generating a supplemental retirement income stream:
- Equity-indexed annuities – Provide guaranteed minimum lifetime income combined with stock market exposure to hedge inflation. Buy them with extended care riders.
- Nontraded REITs – With no public stock listing, they stay semi-illiquid like private equity to focus on long-term dividends over 6-8% rather than short-term NAV jumps.
- Collateralized Loan Obligations (CLOs) – Specialized instruments that provide equity and debt investors regular cash flow averaging 8-10% from pools of corporate loans.
- Dividend stocks – Preferred and common dividend stocks with long histories of steadily rising payouts can supply growing income during retirement for the buy and monitor investor.
- Rental real estate – Direct ownership of rental property throws off monthly cash flow after expenses. But also requires effort as an ongoing part-time job.
| Alternative | Cash Flow | Inflation Protection | Effort Level | Risk |
|---|---|---|---|---|
| Dividend Stocks | Quarterly dividends | Minimal | Low | Moderate |
| Rental Property | Monthly rents | Yes via appreciation | High | Low |
| P2P Lending | Monthly interest | Maybe | Low | Moderate |
| Equity-Indexed Annuities | Guaranteed lifetime income | Yes via the market index | Low | Low |
| Nontraded REITs | Quarterly or monthly distributions | Maybe | Low | Moderate |
Conclusion and Advisory
With pensions disappearing and social security stressed, achieving retirement income security requires creativity these days. The bottom line is that alternative investments can serve as an income-generating enhancement to help relieve retirement portfolio withdrawal rates.
But as discussed, alternatives come with their own set of complexities and risks to navigate as well. So while potentially rewarding, they are not a magic bullet and require due caution.
Some parting thoughts for those exploring alternatives:
- Don’t deviate from your long-term retirement investing goals by chasing exotic alternatives for their own sake. They should fit clearly into your overall plan.
- Work with a fiduciary financial advisor to determine if any alternatives suit your risk tolerance and income timeline as part of a prudent retirement strategy.
- Thoroughly vet any investments yourself also before handing over money since you are ultimately responsible for returns.
- Continuously monitor performance and market conditions for when to rebalance holdings.
Finding the right alternative investments that align with your needs can provide a smoother ride into retirement. But check expectations against reality to make smart choices. With careful planning, alternatives can deliver portfolio stability along with supplemental income to help cover retirement expenses.
FAQs about Alternative Investments for Retirement Income
What percentage of my portfolio should be in alternatives?
Most experts suggest limiting your allocation to alternative investments to 5-10% of your overall portfolio, at least initially. This achieves some diversification benefits without overexposure.
What is the right mix of alternative investments for me?
Work with a financial advisor to determine the right mix aligned with your risk tolerance, income needs, and longevity. A good mix has some near-term cash generators like dividends along with inflation hedges like gold and longevity plays like annuities.
How liquid are alternative investment funds?
It varies greatly. Broadly traded REITs are quite liquid while private real estate partnerships can take months to cash out. Understand the liquidity terms before investing since you may not be able to access your capital quickly.
What fees are involved with alternatives?
This too varies widely. Actively managed funds tend to charge higher fees around 1-2% annually versus passive index alternatives funds charging 0.5% or less. Watch out for complex products like annuities that pile on multiple layers of fees.
What are the tax implications?
Every alternative investment vehicle has different tax treatment for income, capital gains, etc. Private equity vehicles in particular can create tax headaches via the way they distribute and reinvest gains. Consult a tax expert familiar with alternatives.
How risky are alternative investments?
While alternatives aim to reduce systemic market risk for a portfolio, they carry their own unique risks like higher volatility, complexity, lack of transparency, and liquidity restrictions that you must be comfortable with. The risks vary greatly across the spectrum of alt choices.
How much oversight is required?
Some alternatives like rental properties require direct active management as an ongoing part-time job. Others like publicly traded REITs only require occasional monitoring and rebalancing. Match commitments to your bandwidth as an investor.
Are there self-directed options?
Yes, tools like self-directed IRA/401Ks allow you to hold alternative investments in your retirement accounts and even borrow against them while deferring taxes. This keeps more capital working for you but also requires effort and diligence.
