KEY TAKEAWAYS:

• Alternative investments often come with illiquidity, opaque valuations, high fees, and less regulatory oversight, making them risky and complex, especially for retirees.
• Meeting SEC wealth or income thresholds doesn’t guarantee understanding of the complexities or risks of these investments.
• Low-cost, transparent, and simple investment strategies tend to be more effective for retirees than chasing “exclusive” alternative opportunities.

As retirement planning specialists, we’re often asked whether alternative investments have a place in a retirement portfolio. While these types of investments are often marketed as exclusive, high-return strategies, they also come with significant risks and tradeoffs that are often overlooked. 
 

Here’s how we think about them, why they may not align with the goals and priorities of many retirees, and what to consider before adding them (or not adding them) to your portfolio.

What Is An Alternative Investment?

An alternative investment is any investment that falls outside the traditional asset classes of stocks, bonds, and cash.  The most common types of alternative investments you may come across include:

• Private Equity: Investments in private companies (i.e., companies whose stock does not publicly trade on a stock exchange), including venture capital and buyouts.
• Hedge Funds: Pooled investment funds that use a wide variety of different strategies that vary in risk and return potential.  Hedge funds often employ leverage, derivatives, and short selling.
• Private Credit: Funds that invest in a pool of loans made to companies outside of traditional banking channels.

Each of these investment types comes with its own set of potential benefits and drawbacks, which should be carefully weighed before investing.

Why Do People Buy Alternative Investments?

More often than not, people are sold alternative investments (rather than seeking them out on their own).  The vast majority of alternative investments can only be purchased by an accredited investor.  

An accredited investor is an individual who meets specific financial criteria set by the U.S. Securities and Exchange Commission (SEC) to invest in private investment offerings not registered with the SEC.  The financial criteria are either:
 

1. An earned income exceeding $300k joint ($200k individual) in each of the last two years, or 

2. A net worth over $1M, excluding the value of a person’s home.  

So why do such accredited investor requirements exist to begin with? Well, according to the SEC, the primary purpose of this qualification is to “ensure that only investors with sufficient financial sophistication and ability to bear the risks” can participate in these higher-risk investments.  

We find it odd that the SEC is using financial criteria as a basis to judge a person’s financial sophistication and ability to bear risks.  In our decades of providing retirement planning strategies and guidance, we’ve worked with hundreds of people who have net worths and incomes far above these levels, but still have zero basis for understanding the complexities and risks involved in these investments.

How Alternative Investments Are Sold

Despite these complexities, highly credentialed salespeople (often masquerading as financial advisors), along with well-funded marketing departments, put together incredible marketing brochures that dazzle and highlight all of the “benefits” of a particular offering.  

Every alternative investment presents a “unique opportunity” (due to the closed-end nature of the funds) to add diversification (whether it's materially beneficial or not) and earn higher returns because of some brilliant manager or strategy (even if the probability is low).  By the end of the pitch, it seems like a no-brainer.    

What is seldom mentioned in these presentations is that these “benefits” come with significant tradeoffs (recall, you’re an Accredited Investor and it is assumed you understand such things). Below are the main six potential risks and tradeoffs to watch out for.

6 Reasons Why Alternative Investments are a Bad Fit (Especially for Near Retirees)

As financial advisors who exclusively serve as retirement planning specialists, we are not big fans of alternative investments in general, and we do not advise on or recommend them to our clients.  We feel the tradeoffs are far too significant for the “benefits” due to the following reasons:

1. Lack of Liquidity – Alternative investments are typically illiquid.  Investors are often required to lock up their money for several years, with limited or no redemption opportunities during that period.  Obviously, this can be problematic for a retiree who may need access to their funds or want flexibility in their portfolio to optimize withdrawal sequencing during retirement.
    
2. Opaque Valuations - The underlying assets in these funds are seldom traded on public markets, making it difficult to value them accurately.  This lack of transparency can make it hard to assess the actual risk and performance of the fund.
    
3. Higher Fees – Alternative investment funds charge higher management and performance fees compared to mutual funds or ETFs.  A traditional fee structure frequently used is known as “2 and 20.”  This means a 2% annual fee is charged on the committed capital, and the manager gets to keep 20% of the fund’s profits.  These fees can substantially erode returns, especially if the fund underperforms.
    
4. Complexity and Due Diligence - The structures of alternative investment funds can be complex, requiring significant due diligence to understand the risks, terms, and underlying assets.  Many investors and even advisors may not have the resources or expertise to evaluate these funds fully.  It is due to this complexity we chose not to advise on these types of investments.
    
5. Limited Regulatory Oversight – Alternative investment funds are less regulated than public funds, which can increase the risk of mismanagement or fraud.
    
6. Potential for Misalignment of Interests - Fund managers are incentivized to take on more risk to achieve higher returns, which may not align with the best interests of investors seeking stable, long-term returns.  Fund managers only participate in gains, not losses, so it makes sense to them to shoot for the stars.  They get their 2% annually even if they fail.

The Alternative to Alternative Investments? Keep it Simple

If you are nearing retirement, chances are that you have already successfully accumulated a significant sum of wealth.  At this point in your life, avoiding mistakes becomes much more important than trying to hit a home run.  Investing doesn’t need to be “cool” or complicated to work.  In fact, it is traditionally the plain vanilla, low-cost, boring investing that works best.  

We believe retirees are best served by keeping investments simple, transparent, and cost-effective. At this point, their focus should be on building an optimal retirement portfolio that prioritizes stability, tax efficiency, and long-term sustainability. Instead of chasing complex investment products, refocusing energy on areas like tax management and risk management can often create far greater economic value.

If you’d like to review your current strategy and explore what an optimal retirement portfolio could look like for you, you can schedule a call with one of our retirement planning specialists here to get started.