8. Private Loans
Some shrewd people take the route of making loans to private parties. These can be made to individuals or to a business. This can be quite lucrative, particularly if the loans are made to people or businesses that have ample assets or cash flow but also limited credit or a bad credit history. It’s possible for private party lenders to make 8%, 10% or more. These loans can come with upside triggers over time, and it is quite common for a private lender to get collateral that is worth more than the value of the loan.
There are many risks in making private loans. First and foremost, it can be a very difficult process collecting interest payments and getting paid back your principal. Being a private lender also can damage relationships with friends or family. Collecting money from your kids or your best friend is not fun, and it can create friction or fights. Another risk is that if your business or friend runs into financial or tax problems, the IRS or other creditors may jump ahead of the lender and legally demand clawbacks of money the lender received because they had a higher standing over creditors. Another risk that lenders have to consider is when usury law comes into play, which could come with big fines (or worse).
9. Private Equity and Hedge Funds
Many wealthy Americans invest in hedge funds and private equity funds. These are expected to generate returns via income and gains through time. Many funds of this sort have very specific targets or asset classes, while others just look for opportunities regardless of where they are. Or the fund groups may just turn around and invest in stocks and bonds. Generally, except for long-only funds, hedge fund investors are looking for absolute returns, even if it is by profiting from downside. Private equity investors are usually looking for above-market returns through time or they are looking for income and/or long-term gains that are not correlated to the markets. This is where some investors after the Great Recession were looking for returns that were not correlated to the S&P 500.
Even hedge funds and private equity funds managed by very sophisticated and smart investors come with risks. If an investor wants their money back, it can take months or years due to lock-up restrictions or due to what the funds are invested in. If the money is taken back by an investor and the fund is found to have committed fraud, investors may demand clawbacks so that you have to share your proceeds with a larger pool (think about the Madoff scandal). There are still many scams and financial shenanigans that can take place between management fees, operating fees and net performance fees. Another risk in funds like these is that many investors do not even know how their money is being invested for quite some time.
Most investors forget that cash is an asset class in and of itself. You will never get rich having your investment portfolio sit as cash, but you might find yourself at certain times when you have to be liquid. The term “cash is king” still exists, and that can be spent on what you need to buy or it can be saved for a rainy day. Most rich people and those with wealth tend to have cash in an account or on hand, and no one wants to be called “cash poor” despite being wealthy by net worth calculations.
Cash is not immune from risk, and modern times have proven that in a new method. Cash’s value is what the value of what it buys tends to decrease over time. Inflation eats away at cash’s relative value through time. Cash also can be stolen, and that stolen cash may be hard to prove for losses or to the police. Physical cash can get lost, or it can be destroyed or burned. Again, good luck getting that lost cash back, regardless of how it is used.
This is far from an entire list of alternative investments. Other forms of alternative investments include buying insurance policies from their owners. Some people have even made money buying and selling wine and rare whiskey bottles. Government auctions also can sometimes allow for people to buy items on the cheap that can be resold.
Before thinking that avoiding the next stock market crash or the next recession is simple to do in alternative investments, just think back to how illiquid many items became. There was a time not so long ago that many people needed to raise cash and that meant there were fewer buyers of items. There may still be no such thing as a free lunch when it comes to investing.