“Curiosity about life in all of its aspects, I think, is still the secret of great creative people” – Leo Burnett
Most people are familiar with the stock market. There are TV stations which have the stock market and stock market related information on 24 hours every day. It is hard to escape it. When the stock market crashes, it makes the headlines in every newspaper, news station, and media outlet. When it reaches all time highs, it is on every magazine cover, even the shoeshine boys are talking about it. But what about other investments?
Huh? There are other investments?
Yes there are investments outside of the stock market. There is no rule that says you have to invest in the stock market, pitting yourself against the best and brightest investors in the world. Investors compound this problem by investing in areas that they are not experts in. Do you think that is a good idea?
Maybe there is a better way to invest…
Can You Invest Outside the Stock Market?
Peter Lynch famously said , “Invest in what you know.” While he was referring to stocks, the concept is sound. If you are an expert in technology then why not apply your knowledge and expertise into your investments. Invest in technology. Don’t invest in horses, or diamond mines. That would minimize your advantage with your investments. This does not mean you should not diversify your investments, rather it means you should take advantage of your particular skill set and expertise and ply it to your investments to make good choices.
While the stock market provides investors easy access to a wide variety of companies, it is somewhat limited to publicly traded companies. These companies cover a wide range of investments: technology, timberland, transportation, real estate, commodities, health care, etc. , but they are still stock shares in companies run by other people.
You could also invest in bonds of these companies. This is also an investment strategy many people and institutions use to invest their capital. It is a good strategy to use, but why stop there? What else can you invest in?
There is a whole world of investments outside the stock market that individuals and institutions invest in. There are no limits to these investments except for your creativity.
What are Alternative Investments?
The term alternative investments requires some explanation due to its lack of definition in popular media. The term alternative investments does not actually refer to any specific group of investments. It is only a descriptive term typically used to describe investments outside the stock market. Alternative investments can also be available in the stock market, but are typically available in a pooled form. The first investment on the list is a good example of that.
1. Real Estate
Real estate is probably the best known top alternative investment. You are probably already investing in real estate, but there are so many types of real estate, you may not know them all. If you own your home, then you are investing in real estate. While I would not call it an investment, you certainly understand how real estate works. Real estate comes in all forms and different types, but real estate as an investment requires that you are not using it for personal use. Generally it generates cash flow, but it can also be owned for appreciation as well.
Real estate is a broad category that can refer to many different types of property, but for this example lets limit it to residential, commercial, retail, and industrial. Residential real estate is involved in living space. It generally refers to single or multifamily homes. Commercial real estate refers to larger buildings that are involved in commerce or business purposes. This includes office buildings and retail, but also can include apartment complexes. Industrial real estate refers to space involved in manufacturing and production. Examples for industrial are: garages, warehouses, shipping docks, manufacturing facilities.
2. Private Mortgages
If you own your own home, then you probably have a mortgage. This is essentially a loan from the bank to you in order for you to buy your home. This is one of the primary functions of banks. However banks are not the only ones that can provide a mortgage. Anyone can do this. You could be the bank if you wanted. There are a large number of people and institutions who lend money backed by real estate and are not banks. What is even more interesting is that they are typically charge higher interest rates than banks. Why? because they are filling a consumer need that banks are not providing. I’ll give you an example.
Lets say you want to buy a piece of investment property and you can buy it for a big discount to market prices, but only if you can close on it in a week. A bank will never do this. It might take a bank 1-9 months (yes 9 months) to close on a mortgage. If you cannot get a mortgage from a bank, you will have to look elsewhere. Hence the need for alternative funding. There are a number of lenders across the country who lend backed by real estate. The rates that many of these investors require are also much higher. They might be 8-15% in addition to points. While you might scoff at the idea of paying 10% on a mortgage when the banks are paying around 4% today, if you can buy investment property for 20-30% below market price, you won’t mind paying 10% to make this acquisition. Also once you acquire this property, there is no reason you could not refinance it with a traditional lender.
As for the private mortgage as an alternative investment, many people enjoy being the bank. It can provide a stable income while backed by an asset that is easy to understand. The best case scenario for private mortgages as an investment: you get your rate of interest, then the principal is paid back at the end of the note. The worst case scenario: the investor doesn’t pay you the interest and principal back, so you have to foreclose on the property. This would mean your acquisition price of the property is what you loaned to the investor. In many cases this can be an even better outcome than just loaning the money.
3. Tax Liens
Tax liens have long been one of my favorite top alternative investment types. If you are not familiar with what a tax lien is, you are not alone. I suspect that less than 5% of the population has ever heard of a tax lien as an investment. However I’ll bet 80-100% of homeowners would understand what a tax lien is once I explain it.
If you own your home, you pay property taxes to the local town or municipality. This is one of the requirements if you own real estate. These property taxes go to pay for the operations of your town. If you don’t pay your taxes on time, the town penalizes you at a certain rate of interest. If you have even paid your property taxes late, you will know how this works. The town benefits from this interest as well, but this is not always simple.
Lets say that you live in a state like Florida where there is a large population of “snow birds”. People close to or in retirement that travel down to Florida for the winter, but live in a northern state for the summer. While most people pay their taxes on time, some people forget or don’t get around to it until well past when the taxes are due. The town still gets the benefit of the late payment interest, but most of these towns need the money now to fund their operations. If enough people don’t pay on time, then how is a town supposed to pay their employees?
The answer is that the county or municipality holds an auction to auction off these tax liens to investors. These investors pay off the lien in full in order to be able collect the interest payments. This is a win-win for both investors and the town. This is a great deal for the investor since they can receive quite a large rate of interest (18%+) for their capital. This is a great deal for the town, because they get the funds necessary to keep the town running. I will write more about tax liens in a future post.
4. Private Company Stock
While you may be familiar with investing in stocks with your brokerage account, you may not be aware that you can also invest in local private businesses. Many times businesses want to raise capital to expand their operations, or to expand their product lines. They need capital to do this. Some business owners want to sell their business to retire. This is where investors come in. If you want to invest in a business, it does not have to be listed on a publicly traded stock exchange. It can be for any business. Startups, venture capital, and private equity are just some forms of investing in private company stock.
Investing in private company stock can be a great way to productively use your capital. There are many of the same risks as with publicly traded companies, but it can also allow you to bring value to the business with your personal expertise. Some investors have been successful in a prior venture and like to invest in similar companies so they can bring their expertise and knowledge to these firms in an effort to grow their investment without being actively involved in the day to day operations.
5. Structured Settlements
Have you heard of structured settlements before? You are in good company. Most people have never heard of structured settlements. In fact, even many large institutions are not familiar with this asset class. Structured settlement typically fall into 2 categories: Lottery winnings, and life insurance settlements.
Have you ever bought a lottery ticket? As long as this is not your investment strategy, you should be ok. The lottery is a tax on people who are bad at math. However people do actually win the lottery. When they win, they are given a choice, either get paid out over 20 years, or take a smaller amount up front. Many people get paid up front. The way this happens is that the lottery offers to pay the smaller amount up front. However investors also offer this winner an upfront amount (which may be greater than the lottery is offering) in exchange for the full stream of payout from the lottery itself. As a rational person, I would choose to take the larger amount over the smaller one.
Structured settlements as an investment is similar to a bond. The investor pays a lump sum amount up front, then gets paid back his interest and principal over time. Everyone gets what they want out of the transaction. While this can be a great investment strategy, it does require some understanding of how the process works, and it does take some time to complete.
Farmland is technically real estate, but it is also quite different in that it is also a business. There has been a lot of interest in farmland in the past 10 years and this has caused a dramatic rise in the price paid for farmland. Investors are looking at farmland as an investment because it is a renewable resource and sustainable without running out of resources. If you invest in an oil well or a gold mine, eventually you run out of the resource. With farmland, you never run out of the ability to farm on that land (withstanding some obvious risks like flooding, drought, etc).
Investors in farmland can either farm it themselves or lease it out to someone else. Either way, the investor benefits from the cash flow generated from the land. A second benefit is that the land itself should be hedged against inflation. This means that if inflation rises 2%, the price of the land should also rise 2%. The value of your capital will not lose value compared to inflation. In one of my prior posts I show a chart made from Robert Shiller’s data that shows how inflation treats real estate. Jim Rogers, a famous hedge fund manager, has made many claims that farmers will be the next millionaires due to the need of food and value of farmland in the future. Will this be you?
7. Equipment Leasing
Equipment leasing is a small but interesting investment field. I assume you have been to the dentist. well in the dentist’s office are a number of large and expensive pieces of equipment. Most dentists cannot afford to buy this equipment outright, especially when they graduate from dental school with large school loans. They are able to get this necessary equipment by leasing it from equipment leasers. These people own the equipment and lease it to the dentist. If the dentist doesn’t pay the lease, they can come and repossess the equipment.
Considering this as an investment it makes sense to know the equipment and the industry that uses it well. Otherwise you might get stuck with a piece of equipment that is useless to you. The benefits can be great since the yields on equipment leasing can be quite high, but just like any other investment, invest in what you know.
8. Oil and Gas LPs
Most people have heard of Exxon, Conoco, Shell, and Chevron, but they have never heard of Joe Smith the oil wildcatter. While Joe is not a real person, many individuals drill for oil personally rather than in a large multinational conglomerate. Investors like Joe Smith don’t always have money to build and maintain their oil wells, so they have to raise capital. Frequently this capital comes in the form of LPs to private investors.
Investors in oil and gas LPs have the risk of the well not hitting oil, but the benefits to them are the potential that it does hit oil as well as some decent tax benefits regardless of the outcome. This can be quite an investment strategy for the right person. These types of investment can be available through broker dealers as well as directly from the GP.
9. Artwork and Collectibles
Whether or not you are an art lover, you probably have seen the news of the recent auctions held at Christie’s for paintings valued at almost 180 million for just one painting or others valued at 40, 50, or 60 million each. Right now there is a boom in artwork by the ultra wealthy. This may have something to do with all the money that is being made in certain sectors such as finance. However you don’t need to be an art critic or a uber-wealthy billionaire to invest in artwork or collectibles.
Artwork and collectibles include: paintings, sculpture, pottery, coins, wine, stamps, signatures, and sports or historical memorabilia. While most of us will not be bidding at the next Christie’s auction for a Van Gogh painting, there are a number of artwork or collectible pieces that are closer to your price range. There have even been a few art or wine funds created to invest in multiple pieces without taking a large risk on just one. Artwork or collectibles as an investment has a dual purpose. It can certainly be seen as an investment, but it also has the benefit of your personal enjoyment of viewing this piece. As the saying goes, beauty is in the eye of the beholder. Invest in something you enjoy.
Timberland is also real estate related, but it has some unique characteristics that are very appealing to investors. Timberland is basically a plot of land that is growing trees. That is it. Simple right? Well not really. Owning land and harvesting trees off of it can produce some reasonable income for investors, but there are many other components to this investment. Timberland is a renewable resource. A well maintained forest is an investment that keeps on giving. while you can cut trees each year to product income, if you don’t cut them, they will keep growing, making the wood even more valuable. This produces a predictable growth rate if they are bought at the right price. The land also appreciates and there can be some preferential tax benefits as well.
One last benefit for investors is that timberland has a very low correlation to other investments. In the early 2000s timberland had a correlation to stocks and bonds close to zero. That is hard to accomplish. However since the institutions have become interested in this as an asset, the correlations have become closer for timberland and traditional investments. The benefits are still there though. If you invest in timberland and wood prices drop, you don’t have to cut trees, you can let them continue to grow on the stump until prices become more favorable. For these reasons timberland also makes my top 10 list.
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