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Alternative Investments: Pros and Cons

As with any other investment, understand the risks before putting money in the pot.
February 12, 2009
URL: http://www.entrepreneur.com/article/200080

Successful entrepreneurs--especially those who have sold companies or taken them public--are frequently offered investment opportunities that most investors can only read about in the paper.

And I can't say those alternative investments aren't tempting. After all, who wants to settle for the kind of lukewarm returns that you typically get from putting your money in a large-cap mutual fund when you can invest your money in a fund that may produce the next Google or Microsoft? And why should you sit in the bleachers with the other retail investors when you can put your money in private equity deals alongside pension funds and university endowments that have the inside track?

But, as with any other opportunity for creating wealth, you need to understand the risks before you put your money in the pot. VC funds, which have produced some of corporate America's biggest winners, have given birth to their share of dogs. Anybody remember Pets.com? And once you put your money in a VC fund, you may not be able to take it out for the next 10 years--and only if the companies the fund invests in are acquired or go public. Private equity funds, which typically invest in larger, more mature companies with positive cash flow, are less risky than VC funds and often produce higher returns. But private equity funds rely heavily on leverage, or borrowed money, and when the credit crisis hit last year, several large private equity-financed deals went bust.

And what about hedge funds, lightly regulated pools of capital that can hedge market risk and pursue strategies completely uncorrelated to the stock market? Despite the poor performance of many hedge funds in 2008, "investing in hedge funds is probably the best and safest choice among alternative investments for entrepreneurs and small-business owners because of their lower minimum investment, diversification of assets and professional money management," says Galia Gichon, a personal financial expert with nearly a decade of experience on Wall Street and the founder of Down-to-Earth Finance. "However, hedge funds are unregulated and often require investors to keep their money in the fund for at least one year."

So does this mean that entrepreneurs should stay away from alternative investments like these? Not necessarily. While business owners need to make sure their investments are liquid enough to keep their lenders happy, adding a little risk to a portfolio can dramatically improve returns over time.

"As with any long-term investment, be sure you're diversified and don't invest more than 10 percent to 20 percent of your total portfolio in one asset," Gichon says. "If the risks and rewards are properly understood, alternative investments can be a great boost to your long-term portfolio."

The information contained herein is provided for informational purposes only and should not be relied upon in making investment decisions. Before investing, you should always consult with a licensed investment professional. Past performance of investments discussed in this column is not an indication or guarantee of future performance.

Rosalind Resnick is founder and CEO of Axxess Business Consulting, a New York City consulting firm that advises startups and small businesses, and author of Getting Rich Without Going Broke: How to Use Luck, Logic and Leverage to Build Your Own Successful Business. She can be reached at rosalind@abcbizhelp.com or through her website, abcbizhelp.com.