What You Need to Know About Derivatives and Alternative Investments

Welcome to investing 102, where things will get a little more complex. If you haven’t yet, check out the first installment of our investing series here. 

Though most of your investing will be done using the tools we discussed previously (equities, bonds, etc.), it’s important to know of other factors driving the markets. Further, some of the alternative investments are great ways to boost your returns. Others are only invested on your behalf (through mutual funds or pensions), but they may become more accessible over time.

Derivatives
Have you ever seen The Big Short? In the movie, Selena Gomez describes the process of investing in a derivative. Take a look at this video to learn more. 

It’s important to note that a CDO, which is mentioned in the video, is slightly different than a derivative. The difference is this: instead of betting on a bet, as in the movie, a derivative is a bet that something will happen.

So instead of actually buying the currency, equity, commodity or other investment, you’re buying a contract that says, if the investment’s value goes up (or down), I will receive a payout.

There are, for instance, weather derivatives. Futures, or predictions for how currencies or large indices will move, are a major type of derivative as well.

Private Equity
Private equity is simply a share of a company that is not traded on the public market. 

Private equity firms are a major source of capital in the private markets today. These firms buy businesses and streamline them, cutting back on costs with the intent of selling the business or asset in a few years for a premium. 

Most retail investors (aka individuals) are not able to invest in private equity unless it’s in their pension fund or mutual fund. 

Private Credit
Private credit is the flip side of the private equity market: instead of buying a share of a company, one buys a share of its debt. 

Similar to private equity, private credit is difficult for retail investors to access. Additionally, most private credit funds are owned by private equity firms. They invest in both equity and debt (or credit).

Venture Capital
Venture capital is money invested in privately-held startups. These businesses are expected to succeed in the long run, and as a result, shares will be highly valuable and sold at a premium. 

Most venture capital investments are done by VC firms. However, rules passed in the United States in 2015 opened up the market, allowing individual investors to put up to $2,000 into startups in return for shares. 

Real Estate
Real estate includes land and buildings. You can invest in real estate by buying property: a home, an apartment and land count as real estate investments. 

You can also buy a REIT on the stock exchange. Buying a REIT, also known as a real estate investment trust, is like buying a piece of a bunch of properties. There are apartment REITs, warehouse REITs or even hotel REITs.