Investors are always looking for strategies to potentially boost their profits. Some might consider illiquid alternative investments a viable choice. As a professional financial advisor, I want you to know that while these types of investments can come with larger returns, their lack of liquidity can be an obstacle for some investors.
In this article, I explain both the advantages that illiquid alternative investments offer and also the drawbacks you need to be aware of before making any investment decisions. My goal is to help you understand the complete picture so you can decide if these types of investments are a good fit for your situation.
What Are Illiquid Alternative Investments?
Let’s start with a simple definition.
You can think of illiquid investments as a subset within the wider world of investments. Since traditional investments like stocks and bonds are easily bought and exchanged on reputable markets, they’re typically regarded as liquid. On the flip side, illiquid alternatives are difficult to sell quickly.
Examples of illiquid alternative investments include directly owned real estate, venture capital investments, private equity funds, and specific hedge funds. Although the lack of liquidity can be a barrier, some investors may find these alternative investments appealing because they can provide significant returns and diversification advantages.
Advantages of Illiquid Alternative Investments
Even though they can’t be instantly converted into cash, illiquid alternative investments have a number of advantages for a well-diversified portfolio.
First, their connection to conventional equities and bonds is minimal, meaning that they can hold their value or even see positive returns during a stock market downturn, reducing the overall risk of the portfolio. For example, when consumers look for alternatives to homeownership during economic downturns, real estate investment trusts (REITs) can see an increase in rental income.
And second, illiquid alternative investments have the potential to yield large profits. That’s because aggressive-growth businesses with the potential to provide substantial returns for investors are often the focus of private equity and venture capital firms. As a result, investors can potentially improve their long-term prospects for portfolio growth by incorporating a strategic proportion of illiquid alternatives.
Disadvantages of Illiquid Alternative Investments
The biggest disadvantage of illiquid alternative investments is their lack of liquidity.
When a fast sale is needed, it can be difficult or even impossible to offload these options quickly compared to stocks or bonds, which can be easily bought and sold on markets. If you require short-term access to your cash for emergencies, unforeseen costs, or abrupt changes in your financial circumstances, this could be a serious problem. Selling an illiquid investment could require locating a suitable buyer on your own, waiting for an exit window that is specified in the conditions of the investment, or even taking a substantial loss on the investment.
In addition, compared to traditional investment options, illiquid alternatives often have greater minimum investment requirements. This can make it more difficult for smaller investors to participate and increase the amount of money needed up front. Potential returns are further impacted by the fact that management fees for illiquid alternatives are typically greater than those for traditional investments.
Who Should Consider Illiquid Alternative Investments?
Illiquid alternative investments aren’t for everyone. They’re optimally suited for investors with a long investment horizon—typically longer than 5 or even 10 years. This is because these types of investments usually come with lock-up periods, during which your money is unavailable. Short-term investors approaching retirement should avoid illiquid alternative investments because of the difficulty in selling them quickly.
Risk tolerance is another key factor to consider. Alternative investments that lack liquidity are by nature riskier than conventional equities and bonds. The market for these investments can be unpredictable, the underlying assets itself may not be very liquid, and there’s a danger the investment strategy won’t work as planned. As a result, only investors who are comfortable with a greater level of risk and who already have a strong base of lower-risk assets in their well-diversified portfolio should consider illiquid alternatives.
Partner With a Professional
In an increasingly complex world where people are searching for someone they can trust, we stand for something simple: Always put the client first! Our team members at Premier Planning Group follow a carefully planned process designed to give our clients an extraordinary sense of clarity and confidence.
Ready to work with a professional financial advisor to explore whether illiquid alternative investments fit your portfolio?
Reach out by calling our office at (443) 837-2520 or emailing my executive assistant, Talia Grover, at taliagrover@premierplanninggroup.com to set up a complimentary consultation.
About Brion
Brion Harris is the CEO, founder, and managing partner of Premier Planning Group, an independent financial firm specializing in working with pre-retirees and retirees, helping them create customized wealth preservation and retirement distribution strategies. With over 20 years of experience, Brion has developed deep knowledge and skill in helping his clients simplify their finances and find confidence in their financial future. Brion and the Premier Planning team are known for their unparalleled client service and their dedication building long-lasting relationships with their clients. As a result, Brion has been the recipient of the #1 Advisor Leadership Award* at Summit Brokerage Services for eight years running and has a reputation as one of the top retirement advisors in the business.
Brion is a proud 20-year resident of the Annapolis community, where he resides with his wife, Elizabeth, their three children, Addison, Jay, and Scarlett, and their two dogs, Pepper and Coco. When he’s not working, you can find him boating, skiing, traveling, and enjoying good food and music with his family. If you want to learn more about Brion, connect with him on LinkedIn.
The #1 Advisor and Leadership award is based on production data and is awarded by the Summit Financial Networks region of Cetera Advisor Networks LLC. Brion Harris received the award in 2019, 2020, and 2021. This award is not a guarantee of future investment success. This recognition should not be construed as an endorsement of the advisor by any client.
The #1 Advisor and Leadership award is based on production data while at Summit Brokerage Services, Inc. Brion Harris received the award in 2015, 2016, 2017, and 2018. This award is not a guarantee of future investment success. This recognition should not be construed as an endorsement of the advisor by any client.