Alternative investments are outside the traditional categories of stocks, bonds or cash. A wide variety of investments tend to be included: real estate investment trusts, hedge funds, precious metals, managed futures, private equity, venture capital and limited partnerships. Collectibles such as wine, art, antiques and even musical instruments have been packaged as alternative investments.
Many alternatives are less liquid and they are more complex, requiring a higher level of scrutiny and research. Many can only be purchased by accredited investors, who are mainly institutions (like pension and endowment funds) or high net worth individuals.
The investment industry has increasingly been democratizing alternative investments for investors who are not accredited, though. Many strategies previously only available to the wealthy are being packaged into mutual funds and exchange traded funds, both of which provide a higher level of regulatory disclosure and liquidity. Publicly available research by independent firms, like Morningstar, has been expanding as well.
Most investors consider alternatives for their portfolio diversification, especially since in recent years, traditional asset classes have been more highly correlated (i.e., their prices have moved more in tandem). These products act as complements to the major traditional asset classes, and if carefully selected, allocations of 10 to 20 percent can moderate overall portfolio volatility.
Of course, you could always just stock the wine cellar and display the art on the walls and enjoy your alternative investments that way. Some might think that is the best diversification of all!