“Alternative investments” can mean a lot of things, so the first step is making sure we’re talking about the same category.
For purposes of this article, alternative investments are holdings beyond a traditional stock/bond mix (often described as a “60/40” portfolio). This umbrella can include hedge funds, private real estate, private equity, private credit, commodities, and other non-traditional strategies, each with its own risks, costs, and potential role in a portfolio.
The goal in retirement planning isn’t to chase the highest return. It is to build a portfolio that targets the best risk-adjusted outcome possible within the constraints of your situation, including your time horizon, spending needs, tax picture, liquidity needs, and comfort with market ups and downs.
Why investors consider alternatives in the first place
Alternatives are typically considered for three reasons:
- Diversification: Some alternatives may not move in lockstep with stocks and bonds, potentially smoothing the ride during certain market environments.
- Different sources of return: Instead of relying mostly on broad market exposure, alternatives may seek returns from manager skill, specialized strategies, or less-efficient markets.
- Potential volatility management: Certain alternative strategies aim to dampen portfolio swings, though results vary widely and are not guaranteed.
“Just 10% can make a big difference” sometimes
In many portfolio studies, adding a modest slice of alternatives, often around 10%, to a traditional stock/bond mix has historically shifted the portfolio in a desirable direction, with slightly higher returns and similar or even lower volatility.
For example, some long-term analyses (using specific alternative indexes and assumptions) show scenarios where a traditional 60/40 portfolio might have produced one set of historical return and volatility outcomes, while a portfolio with a 10% allocation to alternatives produced a somewhat improved balance of return and volatility.
Two important notes:
- Historical results are not guarantees. The future may look very different, especially as interest rates, inflation, and market structure change.
- “Alternatives” are not one thing. The results depend heavily on which alternatives, how they’re implemented, and what you actually own.
So, while a 10% slice can be meaningful, it’s not an automatic upgrade.
The catch: dispersion of returns can be much wider
With public markets, you can get “the average” return easily. If you want broad U.S. stock exposure, you can buy a low-cost index fund that tracks a well-known benchmark. The dispersion between one S&P 500 index fund and another is usually small.
In many alternative categories, that’s not how it works.
Hedge funds as a simple example
Within hedge funds, there are many different strategies, such as long/short equity, event-driven, global macro, managed futures, relative value, and more. Even within the same strategy, performance can vary dramatically.
That variation is often described as dispersion, meaning the gap between top-performing managers and bottom-performing managers.
This matters because there often isn’t a simple, inexpensive way to buy “the median manager” the way you can buy “the market” with index funds. In alternatives, outcomes can be heavily influenced by:
- Manager selection (skill, process, risk controls)
- Strategy selection (what the manager is actually doing)
- Timing and access (vintage years, entry points, capacity constraints)
In other words, you can have the right idea, diversifying with alternatives, but still get a poor result if the execution is wrong.
The practical trade-offs retirees should understand
Before adding alternatives, it’s worth weighing the very real trade-offs that often come with them.
1) Liquidity constraints
Many alternatives are less liquid than stocks and bonds. Some can only be sold monthly, quarterly, or even less frequently. Private investments may require locking up capital for years.
For retirees or near-retirees who depend on their portfolio for income, liquidity isn’t a minor detail. It can affect:
- How you fund spending needs
- How you rebalance during market declines
- How resilient your plan is during unexpected expenses
2) Fees and complexity
Alternative investment fees are often higher and can be more complicated than traditional mutual funds or ETFs. The total cost may include:
- Management fees
- Incentive or performance fees
- Fund expenses and operational costs
Higher fees don’t automatically mean “bad,” but they raise the bar. The strategy needs to deliver meaningful value, such as diversification benefits, risk management, or return potential, to justify the cost.
3) Transparency and reporting
Alternative strategies may not offer the same real-time pricing and transparency as public funds, and performance reporting can be less straightforward. This can make it harder for investors to know exactly what they own and how it behaves under stress.
4) Tax considerations
Certain alternative structures can create complicated tax reporting and may generate different types of taxable income. Where an investment is held, for example a taxable account versus an IRA, can meaningfully change the after-tax outcome.
5) Behavioral fit
Even if an alternative investment looks attractive on paper, it still needs to fit your personality and planning approach. If you expect daily liquidity and simple statements, some alternatives may feel uncomfortable, especially during uncertain markets.
Who might benefit most from alternatives?
Alternatives tend to be most useful when they’re intentionally selected to solve a planning problem, such as:
- Reducing reliance on stock and bond performance alone
- Adding exposure to real assets as a partial inflation hedge (depending on the asset and structure)
- Seeking different risk factors that may behave differently in certain environments
Investors who may be better positioned to consider alternatives often include those who:
- Have sufficient liquid assets to comfortably meet spending needs
- Can tolerate less frequent pricing and limited liquidity
- Have access to thorough due diligence and ongoing monitoring
- Understand that results can vary widely and are not guaranteed
So, should you include alternatives in your retirement portfolio?
The most accurate answer is: it depends, and that’s not a dodge. It’s an acknowledgement that alternatives can be helpful tools in the right circumstances and frustrating, expensive complications in the wrong ones.
A modest allocation, such as 10%, has, in some historical studies, improved portfolio characteristics like volatility and return, but the real-world outcome hinges on implementation.
A practical decision framework
If you’re considering alternatives, here are a few questions that often clarify the decision:
- What is the objective? (Diversification, income, inflation sensitivity, volatility management, something else?)
- How liquid does this money need to be, especially in retirement?
- How will we evaluate success? Not just performance, also diversification impact, role in rebalancing, and whether it supports the plan.
- Do we have the ability to do manager and strategy due diligence?
- Do the fees and complexity match the expected benefit?
Bottom line
Alternative investments can be a useful diversifier and may improve the overall portfolio experience when executed well. But they are not plug-and-play. The range of outcomes can be wide, and factors like liquidity, fees, and manager selection matter, especially for retirees.
If you’re interested in exploring alternatives, the best next step is to evaluate whether they fit your retirement plan, not just whether they look attractive in isolation. A thoughtful analysis, grounded in your goals, cash-flow needs, and risk tolerance, can help determine whether a traditional stock/bond mix is sufficient or whether alternatives may earn a role in your portfolio.