Fluctuating markets, high inflation and unyielding interest rates make for a challenging environment for traditional asset classes such as stocks and bonds, which tend to move in tandem with market conditions.
As investors look to strengthen their portfolios amid economic uncertainty, alternative investments offer an opportunity for diversification and risk-adjusted returns to enhance the performance of a traditional equity-bond portfolio.
This is partly because, unlike traditional investments, alternatives often are not directly tied to market movements, offering unique opportunities, particularly during periods of market stress.
Sign up for Kiplinger’s Free E-Newsletters
Profit and prosper with the best of expert advice on investing, taxes, retirement, personal finance and more – straight to your e-mail.
Profit and prosper with the best of expert advice – straight to your e-mail.
The Kiplinger Building Wealth program handpicks financial advisers and business owners from around the world to share retirement, estate planning and tax strategies to preserve and grow your wealth. These experts, who never pay for inclusion on the site, include professional wealth managers, fiduciary financial planners, CPAs and lawyers. Most of them have certifications including CFP®, ChFC®, IAR, AIF®, CDFA® and more, and their stellar records can be checked through the SEC or FINRA.
In such times, alternatives can help counterbalance and reduce overall portfolio volatility. Given the broad and sophisticated categories of investments, due diligence and deep expertise are necessary to effectively harness the potential of alternatives for portfolio diversification and other strategic goals.
Enhancing portfolio diversification — and more
Diversification is a fundamental investing principle meant to reduce risk by spreading investments across various asset classes.
A well-structured portfolio should include a mix of traditional and alternative investments, the proportion and purpose of which can vary based on individual risk profiles, goals and market conditions.
These investments not only offer opportunities for capital appreciation and income generation but also play a crucial role in managing risk and helping to achieve long-term financial objectives.
The versatility of alternative investments falls roughly into four categories, each serving different goals:
Portfolio diversification strategies aim to maintain low correlations with traditional equity markets, potentially reducing portfolio volatility and increasing risk-adjusted returns.
Growth-oriented alternatives focus on generating excess returns and wealth accumulation, often leveraging the “illiquidity premium” of private markets through such strategies as venture capital and leveraged buyouts.
Tax-advantaged alternatives are designed to alleviate tax liabilities and offer benefits such as deferred capital gains and tax-managed structures. For example, equity exchange funds can help mitigate concentrated stock positions.
Income-generation strategies seek higher yields and lower volatility compared with traditional fixed income investments, helping to provide reliable income streams and inflation hedging through such products as non-traded REITs and private credit strategies.
Each of these strategies in their own ways can help decouple portfolio returns from traditional market performance and offset the effects of volatility, leveraging alternatives as a source of diversification and more.
Given these advantages, Morgan Stanley Wealth Management’s Global Investment Committee recommends that alternatives constitute as much as 25% of an efficient investment portfolio, tailored to an investor’s net worth, objectives and risk tolerance.
Expanding investor access
While alternative investments were traditionally available only to ultrahigh-net-worth investors, continued innovation has significantly improved access as both demand and product choice continue to grow.
Products such as registered funds and evergreen vehicles — including simplified single portfolio solutions and fully diversified portfolios — offer reduced eligibility thresholds, lower investment minimums, improved liquidity and competitive pricing, as well as easier tax reporting.
Looking for expert tips to grow and preserve your wealth? Sign up for Building Wealth, our free, twice-weekly newsletter.
These features are attractive to investors across the wealth spectrum. The industry has also devoted significant energy to improving the availability of education on alternative investments, helping to demystify and disseminate this important asset class.
The alternatives universe has evolved dramatically, offering qualified investors a variety of choices. Conducting thorough due diligence is vital to understand the underlying assets, strategies and track records of their fund managers.
Manager selection matters in alternatives even more than in traditional investments: There’s an average difference in annualized returns of 12% between top- and bottom-quartile managers, compared with 1.2% among traditional managers.*
It’s important to align the right alternative asset class and strategy with the right management team.
Choosing the right balance
Whether and how to incorporate alternative assets into a portfolio is an ongoing conversation that considers individual financial goals, risk tolerance and investment horizons.
This is where financial advisers can provide critical insights and guidance into how these investments fit into a broader portfolio strategy, helping investors navigate an intricate but potentially rewarding asset landscape.
Alternative investments include private or exclusive opportunities that depend on relationships, networks and deal flows. This is an area of investing in which leadership really matters.
It’s essential to make sure that any allocation to alternative investments fits the individual situation — and integrates into a holistic and comprehensive investment plan designed to achieve specific financial goals.
The right balance should focus on risk and return, of course, but also tax efficiency and personal considerations.
By incorporating alternative investments, investors can achieve greater diversification, access innovative strategies and potentially enhance their portfolio’s overall performance.
* Upper quartile, median and lower quartile based on 10-year annualized returns as of September 30, 2024, via Morningstar, NCREIF, Cambridge Associates, HFRI. For U.S. large-cap, international, U.S. taxable, U.S. high-yield, U.S. core real estate, U.S. non-core real estate, global private equity (consists of buyout and growth equity), U.S. venture capital, U.S. credit opportunities and control distressed and hedge funds. Past performance is no guarantee of future results. Actual results may vary. Indices are unmanaged and investors cannot directly invest in them. They are not subject to expenses or fees and are often comprised of securities and other investment instruments the liquidity of which is not restricted. A particular investment product may consist of securities significantly different than those in any index referred to herein. Composite index results are used for illustrative purposes only, generally do not represent the performance of a specific investment, may not, for a variety of reasons, be an appropriate comparison or benchmark for a particular investment and may not necessarily reflect the actual investments or objectives of a particular investment. Consequently, comparing an investment to a particular index may be of limited use.
Alternative investments often are speculative and include a high degree of risk. Investors could lose all or a substantial amount of their investment. Alternative investments are appropriate only for eligible, long-term investors who are willing to forgo liquidity and put capital at risk for an indefinite period of time. They may be highly illiquid and can engage in leverage and other speculative practices that may increase the volatility and risk of loss. Alternative Investments typically have higher fees than traditional investments. Investors should carefully review and consider potential risks before investing. Certain of these risks may include but are not limited to: Loss of all or a substantial portion of the investment due to leveraging, short-selling, or other speculative practices; lack of liquidity in that there may be no secondary market for a fund; volatility of returns; restrictions on transferring interests in a fund; potential lack of diversification and resulting higher risk due to concentration of trading authority when a single advisor is utilized; absence of information regarding valuations and pricing; complex tax structures and delays in tax reporting; less regulation and higher fees than mutual funds; risks associated with the operations, personnel, and processes of the manager; and risks associated with cybersecurity. CRC# 4605436 (06/2025)
