The number of public companies in the United States has been declining since the mid-1990s. In fact, there has been a roughly 43% decrease in the number of public stocks since 1996. One reason companies are staying private longer is the increased regulatory scrutiny faced by public companies. Additionally, the rise of private equity and venture capital has made it easier for companies to remain private.
However, private equity and venture capital represent just a small portion of the broader alternative investment class. This category also includes commodities, real estate, hedge funds, private credit, structured products, futures, derivatives contracts, currencies, cryptocurrencies, art, antiques, gems, and collectibles.
Alternative investments are typically held by institutional investors or accredited investors—those with $1 million in investable assets or $200,000 in annual income. Qualified purchasers, a subset of these investors, must have $5 million in investable assets. Both thresholds exclude the investor’s primary residence. These high-net-worth individuals are considered capable of assuming greater risks due to the complex nature, higher fees, and elevated risk levels of alternative investments.
In the past, accessing alternative investments often required personal connections or insider knowledge. Today, alternatives are much more accessible through investment advisers and even brokerage firms. Furthermore, investors can gain exposure to the alternative asset class without meeting the accredited investor or qualified purchaser criteria. For example, interval funds—a type of closed-end fund—allow fund managers to invest in alternative strategies requiring long-term commitments and carrying varying levels of risk, from venture capital to private credit.
How can riskier alternative investments be incorporated into a conservative portfolio? Let’s look at an example of a high-net-worth investor who has spent several years converting traditional IRA funds to a Roth IRA to minimize required minimum distributions (RMDs) in retirement. By spreading the conversions over several years, he potentially paid lower taxes annually rather than facing higher taxes on large RMD withdrawals. Now, at age 73, his traditional IRA remains conservatively invested in Large Cap core stocks, but his RMD is less than what he needs to sustain his lifestyle.
To supplement his income without depleting the principal of his Roth IRA, the investor incorporates alternative investments within the Roth to generate income for living expenses. While fixed-income investments might yield approximately 4.5% interest and a diversified, high-quality dividend-paying portfolio could generate around 3.7%, his adviser identified an alternative asset capable of producing closer to 12% annual income. The trade-off for this higher income is several years of illiquidity in the alternative investment.
Ultimately, the alternative asset space is vast and diverse. Investors should work with a financial adviser to monitor these assets and ensure they align with their financial plan, considering both the capacity to handle risk and the liquidity constraints associated with long-term commitments.
If you have questions on whether alternative investments have a place in your financial plan, the experts at Henssler Financial will be glad to help:
- Experts Request Form
- Email: experts@henssler.com
- Phone: 770-429-9166
Listen to the December 21, 2024 “Henssler Money Talks” episode.