Alternative Investments

The Good

While broad index funds should always form the core of your portfolio, the following alternatives serve highly specific, mathematically sound purposes for the right investor.

Fixed Annuities (Longevity Insurance)

A fixed annuity is an insurance contract, not a growth investment. You pay an insurance company a lump sum upfront, and in exchange, they guarantee you a set monthly payout for the rest of your life. The primary downside is significant: the fees can be high, the return rate is lower than the stock market, and once you hand over the money, the principal is gone (meaning you cannot leave that lump sum to your heirs).

However, fixed annuities serve a brilliant purpose for retirees: hedging against "longevity risk" (the fear of outliving your money). Standard retirement math suggests a 4% safe withdrawal rate. If you need $80,000 a year to live, you need a $2 million portfolio, subjecting you to the daily anxiety of stock market volatility.

Alternatively, you could use a fixed annuity to build an unbreakable "floor." If you use $1 million to buy a fixed annuity that guarantees $45,000 a year, your basic living expenses are covered forever, regardless of market crashes. You can then invest your remaining $1 million in the stock market. Withdrawing 4% from that yields another $40,000, bringing your total income to $85,000. You have effectively increased your spending, guaranteed your survival, and transferred the stress of market crashes to an insurance company—at the acceptable cost of capping your upside. You can use Fidelity's Guaranteed Income Estimator to run your own numbers.

Managed Futures

Managed futures are the textbook definition of a true alternative investment, but they are incredibly polarizing. Run by algorithms, these funds are designed to detect and ride price trends across global equities, bonds, currencies, and commodities.

Unlike many other popular alternatives, managed futures do not lock up your money or use fake accounting to hide their volatility. They trade transparently in ETFs and historically possess near-zero correlation to the stock market. Because they can easily short a market, their primary use case is providing "Crisis Alpha." During massive global crashes, like the 2008 financial crisis or the 2022 inflation shock, managed futures algorithms typically detect the downward trend and generate massive positive returns while everything else suffers.

Managed futures look terrible as a standalone asset, as they:

• Generate bond-like expected returns (4% to 6%)

• Carry stock-like volatility

• Are tax-inefficient

• Can go through multi-year stretches of 0% returns during while stocks soar

However, the way to view this asset is not as a growth engine, but as an insurance policy. Because they lower your absolute expected returns, young investors in the accumulation phase should completely ignore them and stick to 100% stocks. However, for retirees who need to protect their wealth from severe drawdowns, especially inflationary crashes where traditional bonds fail, allocating a small slice of a tax-advantaged retirement account to managed futures (like DBMF or KMLM) is a strong consideration.

Real Estate

Real estate has worked out for tons of people, but its role in a portfolio is heavily misunderstood. First and foremost, your primary residence is consumption, not an investment. While your house will appreciate in value over time, historically, a primary residence appreciates at a rate just slightly above inflation once you account for maintenance, property taxes, insurance, and mortgage interest.

As a true investment, real estate generates returns through rental income and leveraged price appreciation. While this can be highly profitable, being a landlord is a hands-on, part-time business, not a passive investment. The greatest mathematical drawback to owning physical real estate is idiosyncratic risk (a severe lack of diversification). While a basic stock index fund allows you to own a piece of 10,000 companies globally, a real estate investor usually has a massive portion of their net worth tied up in just two or three properties located in a single zip code. If that specific local economy falters or a major employer leaves town, their entire portfolio suffers. Physical real estate is a fantastic wealth builder, but it requires significant effort, leverage, and a high tolerance for concentrated geographic risk.

For investors who want real estate exposure without the hassle of being a landlord, the financial industry offers indirect methods. However, for the average evidence-based investor, these are usually unnecessary:

REITs (Real Estate Investment Trusts): REITs are companies that own and manage income-producing properties (like apartment complexes, malls, or data centers) and trade on the public stock market, or via private platforms like Fundrise. While they solve the concentration and effort problems of physical real estate, academic finance does not view REITs as a distinct "alternative" asset class. Their historical returns and volatility can be almost perfectly replicated simply by holding a mix of small-cap value stocks and corporate bonds. Crucially, REITs are already included in total market index funds, making up about 3% to 4% of the index. Buying a separate REIT fund doesn't increase your diversification; it simply makes a concentrated, overlapping bet on the real estate sector.

Farmland: Investing in farmland operates on the exact same logic as REITs. It is a tangible, finite asset that produces cash flow (crop yields and land leases) and acts as an excellent historical hedge against inflation. You can access it through specific ETFs or fractional investing platforms. However, just like commercial real estate, publicly traded agriculture companies and land-holding trusts are already represented in broad market index funds. Dedicating a specific portion of your portfolio to a farmland fund simply means you are actively choosing to overweight the agriculture sector, taking on uncompensated sector risk for an asset you likely already own.

The Bad

The financial industry spends billions of dollars marketing "alternative" investments to everyday investors, usually promising high returns, exclusive access, or low correlation to the stock market. However, when you look past the marketing and examine the math, the vast majority of these assets suffer from extreme fee drag, uncompensated risk, or artificial illiquidity. For the evidence-based investor, these are generally areas to avoid.

Commodities

Commodities are raw materials or agricultural products. Unlike a business that generates profits or a bond that pays interest, commodities produce no cash flow. Their only return comes from price speculation—hoping someone else will pay more for it later. Furthermore, commodities actually cost money to store and insure, creating a negative yield.

Gold, in particular, is heavily marketed as an inflation hedge. What people fail to understand is that this is only true over extremely long periods (centuries). Gold has never been a reliable hedge against short-term inflation, and while it occasionally goes up when stocks go down, it possesses stock-like volatility with an expected real return of zero over the long run. This dynamic is even more pronounced with highly volatile, less mainstream metals like silver, or energy and agriculture futures. If inflation is a primary concern, Treasury Inflation-Protected Securities (TIPS) are a mathematically superior, cash-flowing alternative.

Private Credit

Private credit is non-bank lending to private businesses. It has drawn in many investors due to the promise of high, stable returns with low market correlation. However, the problems start with the fundamental reason these loans exist: the borrowers are too risky to get a standard loan from a traditional bank.

This leads to high default rates. Furthermore, because these loans are not publicly traded, private credit funds do not have to "mark to market" daily, creating an illusion of price stability that hides the true underlying volatility. Because these funds lack liquidity, distributions and redemption windows are frequently frozen during economic downturns, meaning you cannot withdraw your money when you need it. Finally, any excess yield is almost entirely eaten up by massive fee structures (commonly a 1.5% management fee plus a 15-20% performance fee). You end up taking on stock-like risk for bond-like returns, with zero liquidity.

Private Equity (PE)

Private equity funds raise capital to buy out mature companies, restructure them (often by loading them with debt), and attempt to flip them for a profit. The primary appeal revolves around the "illiquidity premium"—the theoretical idea that locking up your money for 10 years should yield higher returns.

However, the data shows this premium largely fails to exist in modern private equity. Once you account for their exorbitant fee structures (the classic "2 and 20"), PE fund managers generally do not outperform basic, low-cost small-cap public index funds. While tempting due to the illusion of exclusivity and diversification, investing in PE means locking up your capital for a decade, paying massive fees, and taking on heavily concentrated, uncompensated risk.

Venture Capital (VC)

Venture capital, similar to private equity, locks up capital to invest in private companies. The difference is that VC focuses on early-stage start-ups rather than mature companies. The returns in VC are extremely skewed: roughly 90% of start-ups fail, and the entire return of a fund usually relies on one or two companies becoming massive "unicorn" successes.

While top-tier VC managers do exist who consistently perform well, their funds are strictly closed to new or retail investors. The VC funds that are accessible to everyday investors are usually capturing the "scraps" that the top-tier firms passed on. Like private equity, entering this market as a retail investor usually leads to paying high fees for severe underperformance and extreme idiosyncratic risk.

Hedge Funds

Hedge funds are exclusive, private funds that use complex, high-risk vehicles—like heavy leverage, short selling, and derivatives—to try and generate "alpha." The name implies they protect (or "hedge") against market downturns. In reality, the extremely high fees eat away at any excess returns, and their correlation to the broader stock market conveniently skyrockets during the worst crashes, meaning they fail to protect you when you need it most. While there are famous historical cases of well-performing hedge funds, they suffer from the same fate as popular active mutual funds: they perform well early on, then severely underperform after massive amounts of investor money flood into them.

IPOs (Initial Public Offerings)

An IPO occurs when a private company first offers its shares to the public stock market. They are accompanied by massive media hype and the promise of getting in on the "ground floor." However, the IPO process is heavily skewed in favor of institutional investors. Investment banks underwrite the IPO, setting the initial price and allocating the best shares to their largest clients (hedge funds and wealthy insiders) before the stock ever hits the public exchange. By the time an everyday retail investor can buy the stock on opening day, the price has already surged. Data shows that the average IPO significantly underperforms the broader stock market over the subsequent three to five years as the initial hype fades and early insiders lock in their profits.

Startup Crowdfunding

Startup crowdfunding allows everyday people to act as "retail venture capitalists," buying tiny equity stakes in highly speculative private companies. The fundamental flaw here is "adverse selection." If a startup is truly promising, it will easily secure funding from top-tier professional VC firms who offer strategic guidance and industry connections. Startups that resort to raising money from the general public via crowdfunding are often the ones that the "smart money" already passed on. Furthermore, these shares are completely illiquid; even if the company succeeds, you cannot easily sell your shares until the company goes public or gets acquired, which can take a decade, if it happens at all.

Peer-to-Peer (P2P) Lending & Real Estate Debt

P2P lending platforms bypass banks, allowing you to lend your money directly to other individuals for personal loans or short-term real estate flips. They advertise incredibly attractive yields (often 8% to 12%). However, similar to Private Credit, you face the adverse selection problem: why is this person borrowing from you at 12% instead of getting a 7% bank loan? Because the bank deemed them too risky. The default rates on these platforms are notoriously high, and once taxes and platform fees are deducted, the actual realized return is often worse than a risk-free government treasury bond. You are taking on immense, uncompensated credit risk for a mirage of high yield.

Fractional Collectibles

These platforms allow you to buy "shares" of alternative tangible assets like fine art, rare wine, or classic cars. The pitch is that these assets do not correlate with the stock market. However, just like commodities, art and wine produce no cash flow; they only cost money to store, insure, and authenticate. These platforms charge incredibly high management fees (often wiping out 1.5% of your investment annually) and take a massive cut (often 20%) of any eventual profits. Furthermore, you have zero control over when the asset is sold, meaning your money is entirely illiquid until the platform decides to liquidate the item.

Large-Cap Cryptocurrency

Cryptocurrencies are decentralized digital assets. While the underlying blockchain technology is fascinating, cryptocurrency as an investment lacks fundamental value. Because crypto produces no earnings, pays no dividends, and generates no cash flow, it cannot be valued using traditional financial metrics. Its price is driven entirely by the "Greater Fool Theory"—the hope that someone else will pay more for it tomorrow than you paid today. While large-cap cryptos have generated massive historical returns for early adopters, they remain highly speculative, wildly volatile assets that have repeatedly failed to act as reliable inflation hedges or safe-haven stores of value during broad market panics.

The Ugly

These assets combine extreme risk, mathematical disadvantages, and zero-sum mechanics. They should be avoided entirely by long-term investors.

Variable Annuities

While fixed annuities provide a valuable safety net for retirees, variable annuities manage to combine the worst aspects of both investing and insurance. With a variable annuity, your payouts fluctuate based on how the underlying mutual funds perform. The marketing pitch is that you get "market upside," but if you want market upside, you should simply invest in the market directly. Variable annuities strip away the one true benefit of an annuity—the guaranteed safety floor—while still subjecting you to exorbitant insurance fees, surrender charges, and the forfeiture of your principal.

Derivatives (Options, Futures, Swaps)

Derivatives are financial contracts whose value relies entirely on an underlying asset. Thanks to zero-commission trading apps, options and futures have become incredibly popular in the retail world, largely treated like lottery tickets. However, derivative trading is a strict zero-sum game. For every dollar you win, someone else must lose a dollar. When you trade options, you are actively betting against Wall Street algorithms, institutional hedge funds, and market makers who possess vastly superior data, speed, and capital. For a retail investor, this is pure gambling, not investing.

Forex (Foreign Exchange)

Forex is the trading of international currencies (e.g., betting the Euro will rise against the US Dollar). Unlike a company that creates products or a bond that generates interest, currencies do not generate cash flow. Therefore, currency trading has an expected real return of exactly zero. It is pure speculation driven by shifting global interest rates and geopolitics. If you want exposure to foreign currencies as a natural hedge, you automatically achieve this simply by holding international stock index funds (like VXUS).

Miscellaneous Speculative Assets

This category serves as the graveyard for unregulated, highly leveraged, or fundamentally worthless assets driven purely by hype. This includes NFTs (Non-Fungible Tokens), micro-cap "meme" cryptocurrencies, and extreme-risk trading strategies like writing naked calls. Buying these assets relies entirely on the "Greater Fool Theory"—the hope that you can buy a worthless asset today and find a greater fool to buy it from you for more money tomorrow.