Here's what to know about alternative investments before buying

After a tough year for the stock and bond markets in 2022, some advisors are turning to alternative investments, according to a new survey from the Financial Planning Association.

Nearly 30% of advisors are actively investing in or seeking alternative investments, or “alternatives,” for clients, the findings show. These assets typically fall outside traditional investments in publicly traded stocks, bonds and cash.

Some investors are drawn to alternatives for diversification, lowering portfolio risk and boosting returns, said certified financial planner Ashton Lawrence, director at Mariner Wealth Advisors in Greenville, South Carolina.

Indeed, “diversification” and “risk mitigation” were top objectives among advisors who recommend alternatives, according to the FPA survey.

However, there’s variation among risk and return, with many assets falling under the “alternatives” umbrella, including hedge funds, private equity, “real assets” such as real estate or commodities and prepackaged investments known as “structured products.”

“The big thing I harp on is conducting thorough due diligence,” Lawrence said, noting the importance of understanding the product, why you’re buying it and how it fits with the rest of your portfolio.

A ‘lack of liquidity’ and higher fees

While some advisors recommend alternatives, nearly 30% are “familiar” with them but are steering clear, the FPA survey found.

For many advisors, the biggest obstacle was the “lack of liquidity” with certain products, especially amid economic uncertainty and higher borrowing rates.

Here’s what to know about alternative investments before buying

That risk isn’t understood well by many investors, explained Chris Mellone, a CFP and partner at VLP Financial Advisors in Vienna, Virginia. “It’s just really tough to get out of some of these funds.”

Fees and expenses were other challenges for alternatives, and those tend to be higher with certain products, according to Lawrence. “That’s nothing really to frown upon if the value is there and you can justify the expense,” he said.

“But if all you’re doing is paying for an expensive money market fund, I would say you’re probably better off trying to find another strategy,” Lawrence added.