Alternative investments often require a certain level of patience as many of these assets lack the liquidity inherent in the public markets. However, there are several benefits associated with taking a long-term approach by investing in illiquid alternatives.
(1) Avoiding Market Volatility
Alternative assets often mitigate market volatility present in more traditional investments like those found in the public markets. These risk mitigants are put in place by investing in asset classes like private equity, as well as adhering to certain strategies represented by many hedge funds.
Investors have the tendency to react hastily when markets turn sour as they generally lack the ability to fully understand the underlying causes of this volatility. The inherent illiquidity of alternative investments creates a natural hedge against the myopic knee jerk reaction of the average investor.
(2) Lower Transaction Costs
Short-term investing often requires high amounts of turnover, leading to the creation of high transactions costs. While short-term investing sometimes yield high returns, many of these benefits are offset by the costs of maintenance and rebalancing of a portfolio. It is often difficult to create a model to generate an efficient portfolio for maximized returns while limiting high transaction costs.
Alternative investments often have higher upfront fees compared to other traditional investments, but this is often mitigated by the fact that these investments are typically not subject to high turnover and ongoing maintenance and transaction costs.
(3) Tax Benefits
While not unique to alternative investments, long-term investments (longer than 12 months) have certain tax benefits. These longer-term investments are subject to long-term capital gains tax, which is lower than the taxes incurred from short-term investments. Additionally, capital gains tax is generally only incurred upon realized gains. As a result of the longer holding periods of illiquid alternatives, these investments may hedge against short-term capital gains taxes. Consult with your financial consultant and/or tax advisor in order to determine which investments may be best suited for your portfolio and long-term investment strategy.
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