Young, wealthy investors are turning to alternative investments

Young, wealthy investors don’t want their parents’ investments.

If you’re between the ages of 21 and 43 and have at least $3 million in investable assets, your preferred investments likely aren’t your traditional mix of stocks and bonds, according to new research from Bank of America.

Nearly one-third of young, wealthy investors’ portfolios are in alternative assets like hedge funds, private equity, and crypto and digital assets, according to Mike Pelzar, head of investments at Bank of America Private Bank.

Meanwhile, less than half of their portfolios are in traditional stocks and bonds.

That’s in contrast to wealthy investors ages 44 and up, who have about three-quarters of their portfolios allocated to stocks and bonds, and only about 5% in alternative assets like hedge funds, private equity and real estate, he noted.

“The two different cohorts think very differently about what the greatest opportunities are for growth with their investments,” Pelzar said.

Younger investors’ appetite for alternatives isn’t expected to let up, with 93% indicating they plan to use more of those investments in the next few years, Bank of America’s research found.

Much of the difference between younger and older wealthy investors’ outlook comes down to what kind of investments they grew up with, Pelzar explained.

“This younger generation has enjoyed much greater access to a broader set of asset classes than the older generation did as they were growing up,” Pelzar said.

The younger generation may also have less trust in traditional stocks and bonds after having lived through the financial crisis and dot-com bust. More recently, the increased correlation between equities and fixed income may be prompting them to diversify their assets.

“They’re looking to spread around the risk,” Pelzar said.

At the same time, younger, wealthy investors also have higher cash allocations, the research found. Some experts worry having more cash can lead to missing out on bigger market returns, even as today’s elevated rates guarantee the highest interest on cash in more than a decade.

“Underinvesting is a risk, and it’s one that I think more younger investors are susceptible to,” Callie Cox, chief market strategist at Ritholtz Wealth Management, recently told CNBC.com.

But higher cash allocations may make sense for younger, wealthy investors who have a lot of their net worth tied up in alternative investments that tend to be more illiquid, or who are planning to make big purchases, like buying a home, Pelzar said.

Another reason why young, wealthy investors may be turning to alternatives is because they have more choices.

“There’s never been a bigger menu of opportunities to put your money into,” said Douglas Boneparth, a certified financial planner and president of Bone Fide Wealth, a wealth management firm based in New York City.

When diversifying to alternatives, it’s important to be aware of the potential costs involved, said Boneparth, who is also a member of the CNBC FA Council.

Alternative investments may require your money to be locked up for a certain period of time, he said.

Alternatives may also come with unique costs, such as the 2 and 20 fee structure. It’s a fee arrangement that is standard in the hedge fund industry, and is also common in venture capital and private equity, where an annual management fee of 2% is charged for managing assets and a 20% standard performance or incentive fee applies to profits made by the fund above a certain predefined benchmark.

Expense ratios — management fees charged by investment funds — may also be higher for alternatives, Boneparth noted.

If you’re invested in an area like collectibles, the bid-ask spread — or the difference between quoted prices for a sale and purchase — may be larger or more unpredictable, he said.