Alternative Investments are one of the following: commodities, commodity future contracts, ETN’s, various exotic strategies used by hedge funds, buying an option on a volatility index, short selling, derivatives, covered or uncovered call or put writing strategies, also direct ownership in timber farms, oil drilling ventures, etc.
What is not an alternative investment would be straight forward ownership of stocks, bonds, real estate, bank CD’s, etc. During the great bubble of 1997-2008 when “real” interest rates were very low many investors felt that investment returns were too low and so they “plunged” into riskier alternative investments in the hopes of making a profit.
If an investor insists on investing in alternative investments then they should do an integrated financial plan to examine if they can handle this risk how much risk they can handle. If someone wants to buy alternative investments then it is important to have a diversified and uncorrelated portfolio, where the goal is to have risk of one asset offset by the potential gain of another asset that moves in opposite direction. However, during crashes most classes of investment assets tend to go down together.
Tax consequences should be examined by the client so that the client can decide if the tax traps of alternative investing are worth tolerating. For example, these could create UBI inside of an IRA which is not allowed by the tax code. Short term gains (instead of long term gains), loss of the 15% dividend tax rate, denial of interest deductions, capital losses over $3,000 that must be deducted over many years are all examples of tax risks associated with alternative investments.
Gains from commodities contracts and from collectibles are taxed at higher rates than stocks. However, holding them in an IRA is not appropriate because IRA’s should be a place for low risk funds for one’s retirement. Further some exotic investments such as collectibles, or bullion are not allowed in an IRA or 401k, etc.