Nontraditional Investments

While I've spent a lot of time discussing the finer points of choosing the right types of investment accounts and allocating your investment contributions to minimize the taxes you pay, my conclusions concerning what to invest in have been pretty boring.  Whether the money is in a Roth IRA retirement plan or a 529 college savings plan or a military Thrift Savings Plan or any other investing world account acronym, the story is the same: you are best off investing in broad-based, passively-managed index mutual funds.  While the historical context and ultimate triumph of the index mutual fund deserves an article of its own, suffice it to say that any financial expert with an honest, undivided interest in the investor's well-being will give exactly this advice.

To be crystal-clear: that is definitely all you need to know.  From your first investment order all the way through retirement, index mutual funds are by far the surest and most straightforward path to accomplishing your financial goals.

That being said, technology is allowing the proliferation of all manner of new and interesting investment opportunities.  This article focuses on opportunities that meet my definition of the optimal investment:  a low barrier-to-entry, a small minimum investment requirement, limited input of time, energy, and expertise, and minimal fees — plenty has been written elsewhere about effort- and expertise-intensive investments such as real estate, so I won't go into them here.

Keep in mind that these opportunities are new and untested, and likely contain levels of systematic risk that are orders of magnitude greater than index mutual funds.  Consider these opportunities only if you are an advanced investor, and limit your overall use of non-traditional, non-diversified investments to ~5% of your portfolio.  Professional investors would call this allocation 'fun money', and that is a very fitting name.

The usual investing rules apply:
 • if it sounds too good to be true, it probably is
 • the more complicated a financial instrument, the greater the magnitude of its fees and hidden risks
 • never invest in anything you don't understand

Peer-to-Peer Lending

The concept here is simple: you help finance a loan to an individual by buying a stake in the loan.  Stakes are typically called 'Notes', and are usually sold in ~$25 increments.  As the borrower pays back the loan, you receive principal and interest payments in proportion to your stake, minus fees paid to the peer-to-peer lending platform.

Peer-to-peer lending has been growing in a huge way over the last five years, as is evidenced by this graph of total loans issued by Lending Club, the largest peer-to-peer lending platform:

Most borrowers (81% as of today) use their loans to pay off high-interest credit card debt.  As this debt can easily be in the 20-30%+ interest range, these lenders are happy to take a loan at 10-25% in order to pay it down.  After Lending Club's fees and the risk of borrower default, that still leaves the investors with a very nice interest rate:

I personally have nearly 5% of my portfolio invested with Lending Club.  My current net annualized return is 20.2%, but the loans have terms of 3 or 5 years and I have only been investing for one year — I expect the default rate to pick up over the coming months, though I'd still be thrilled if it left me with 12+%.

Unlike index mutual funds, peer-to-peer lending is not entirely hands-off: the platform provides you with credit information on each available borrower, and you must choose which Notes to invest in.  If you are looking to invest a large sum of money, this may take a significant amount of time.  For the volume that I am trading in, I find sorting through the information and 'playing bank' to be fun.

Lending Club has been having some problems recently keeping up with the demand for loans to invest in, but they're working hard to increase loan volume without sacrificing quality.

The two biggest competitors in this arena, Lending Club Investing and Prosper.com, are worth consideration.  If you're looking to pay down high-interest debt, you can also join Lending Club as a borrower and take out a loan.  LendingClub is a favorite alternative investment of Mr. Money Mustache, and he has prepared a series of articles on the platform.

Crowdsourced Project Investing

Crowdsourcing has entered the mainstream.  The platforms cover the full consumerism–philanthropism spectrum: Kickstarter is basically a preorder engine for all manner of products before they're even created, Kiva lets you participate in microloans in the developing world, Microryza involves you in the funding of scientific research projects, and Indiegogo connects you with all manner of causes and organizations looking to build something new or make a difference.

Enter Mosaic: socially-conscious investing for fun and profit.

The concept is again pretty simple: team up with other investors to fund solar power installation projects.  Over the next ten or so years, collect principal and interest payments as the installation produces power and the loan is paid back.  Very few banks are interested in financing alternative energy projects, so the door is open to make a difference while collecting some very solid returns.

Projected returns after fees on the projects currently under offer are an impressive 5.75%.  Compare this to 2.94% for a 10-year US Treasury bond.

Unfortunately, you must be a resident of California or New York or an Accredited Investor (income >$200k, net worth >$1MM) to participate.  Mosaic is working hard to expand participation.

I personally have slightly less than 1% of my portfolio invested with Mosaic, but my experience with the platform has so far been a good one.

Personal Angel Investing

This one's currently for Accredited Investors only, but the concept is interesting enough to be worth mentioning.  Upstart allows investors to invest in promising individuals by buying stock in their future income.  Investors are encouraged to mentor the 'upstarts' that they invest in.

Some additional specifics: Upstart uses statistical models to estimate an individual's future income potential and set the cost to investors for a share of that income.  An individual may only put up to 7% of their income up for investment.  Income is shared for either five or ten years.  Payments are waived for years in which the individual makes less than a set minimum amount, but extension years (up to 5) are added to the agreement when this occurs.  The platform targets an 8% annual return for investors, but they admit that this is not based on historical data and is extremely speculative.

I am not (yet) an Accredited Investor, so I don't have any investments in this platform.  The concept — especially the mentoring aspect — does seem very promising, and Upstart has attracted a well-decorated cadre of investors.

Daytrading/Stock-Picking/Options Trading

Casino's that way, chief.  Do not waste your time: you cannot win against the investment bankers, the supercomputers, and the Warren Buffets.

So there you have it: a couple ways to add some fun, further diversification, and maybe even social responsibility to your portfolio.  Just remember to make index mutual funds your cornerstone and restrict the 'fun money' to ~5% of the total invested!

Know of other interesting alternative investments?  Let me know in the comments and I'll look into it.