When building a robust wealth management plan, successful closely held business owners and affluent families may eventually want to consider alternative investments. Unavailable to many investors, alternative investments are classified as those that follow different rules, have higher investment minimums, or invest in different asset classes than the typical retail investment.

“Alternative investments have gained popularity in the past couple of generations. The perception is that there are more talented investors and managers behind some of them or better formulas,” says P. J. DiNuzzo, Founder and Lead Consultant of DiNuzzo Middle-Market Family Office™ and author of the Wall Street Journal bestselling book, The DiNuzzo Middle-Market Family Office™ Breakthrough: Creating Strategic Tax, Risk Cash-Flow and Lifestyle Options for Successful Privately-Held Business Owners and Affluent Families. “These include private equity and private credit, or private and classic hedge funds. These funds often have a material management fee and/or performance fee involved that needs to be considered before investing. Certain private real estate investments can also be considered alternative investments, because of their atypical rules and structure.”

Mistakes People Make When It Comes to Alternative Investments
Trouble typically comes when investors do not fully understand what they are buying. This applies to any investments, especially those less common. The farther away from the main path one treads, the easier it is to get lost if you do not have someone guiding you. 

If someone does not understand the fundamentals of an investment, and cannot connect it to a bigger picture, he or she needs to be extremely cautious. For example, many investors fail to realize all the fees involved in each alternative investment, such as the ongoing and performance fees. In addition, restrictions frequently apply to both contributions and withdrawals.

“A common mistake is failing to connect these investments to a comprehensive wealth plan. In other words, the investor buys into an alternative investment in a vacuum and might not be the right fit considering the full picture of the investor’s investment and wealth planning goals. To avoid this mistake, each investment should be evaluated as to how it fits into the full wealth plan and goals of the investor. Unfortunately, many investors fall into the shiny object syndrome and buy into a charismatic manager’s pitch,” adds P. J. DiNuzzo.

He went on to say, “If you don’t understand the big picture of what’s happening, you should not leap forward. Any asset manager should make you feel comfortable and help you understand the investment. If you fully understand the fundamentals do not invest.” Therefore, the first thing investors should look for is someone who can clearly explain the benefits, risks, and fees, and describe how the proposed investment might be the right type of investment for you.

According to Mike DiNuzzo, Senior Vice President, Principal, and Risk Management Team Leader at DiNuzzo Wealth Management, “Middle-market business owners with $5 million or more in investable assets could benefit from alternative investments. The buy-in for many of these plans is in the hundreds of thousands or even millions of dollars. So, the investor must be willing and able to put this amount of money into the fund, sometimes locking it up for years. This also goes for private real estate, since the asset may take years to appreciate, and isn’t very easy to liquidate.”

How to Decide to Invest in Alternative Investments
Mike DiNuzzo advises his clients this way: “First, consider your overall financial goal. Never buy into a plan or make a significant purchase on a whim. Develop a full wealth plan first. This could mean sitting down with a wealth advisor or family office consultant to review your full wealth, business, and life picture. Then, when considering which alternative investments to invest in, if any, review multiple options, not just one that seems popular at the time.”

For this, it is often best to work with a family office practice that understands the vast universe of alternative investments available to affluent families and business owners. A family office practice takes a client-centered approach, considering their financial picture and goals first and only then matching investments to the client. The professionals in the family office practice need to go over the options in plain language with business owners or the affluent and not simply pitch what P.J. DiNuzzo would call a “shiny object” to them.

RUSS ALAN PRINCE is the Executive Director of Private Wealth magazine (pw-mag.com) and Chief Content Officer for High-Net-Worth Genius (hnwgenius.com). He consults with family offices, the wealthy, fast-tracking entrepreneurs, and select professionals.