Investing in non-traditional assets: what is the value of my promissory note?

What is the value of my promissory note?

Traditional investment assets

Stocks, bonds, mutual funds, and exchange-traded funds are examples of “traditional investment assets.”
The value (price) of these assets is public information that is published daily. Its value may fluctuate by the hour, but it is always known.

Non-Traditional Assets or Alternative Assets

Alternative assets are not publicly traded. Its value (price) is not published and is not available from any central source. They are bought and sold individually, privately, without public disclosure. Examples include real estate, commodities, rare coins, stamps, works of art, LLCs, and private notes. Recently, the term has been used to refer to other asset classes, such as private equity, venture capital, and hedge funds. An accurate valuation of these assets generally requires a professional appraisal report from a third party. There is no public pricing information available.

Liquidity

Liquidity means that an asset can be converted into cash easily, quickly and cheaply. Alternative assets (non-traditional financial assets) are less liquid than regular assets. Therefore, investors who consider alternative assets are investing in the future; liquidity is sacrificed.

Advantage

The main advantage of alternative assets is that they help diversify an investor’s portfolio and offer higher potential returns. Since they are non-traditional investments, they do not move in the direction of the stock market and therefore can help a portfolio offset market volatility. Also, due to lower liquidity, alternative assets are often mispriced and thus offer arbitrage opportunities.

Disadvantages

Due to their non-traditional nature, alternative assets are more difficult to add to a portfolio. Therefore, banks may charge an additional fee for holding the asset. Depending on the returns earned from the asset, additional tax forms may need to be filed. Its illiquidity is also seen as a major drawback, as properly liquidating and valuing the asset can take some time.

Fair Market Value (FMV) vs. Net Asset Value (NAV)

When these two value definitions are used for the same asset, two different values ​​(prices) result for the same asset, depending on the definition selected. People need to be clear about what they mean by “value” or they may get two conflicting values ​​for the same asset.

Fair market value is the price at which shares of alternative assets would change hands between willing buyers and sellers in separate transactions. It is the amount an investor could get for their REIT, note, hedge fund, or other alternative asset shares if they were to find a buyer and sell today.

To reach the FMV, several risk factors are considered, among them: Lack of control (minority interest); lack of marketability; lack of liquidity; Transfer Restrictions (including SEC restrictions); and Time horizon to maturity.

Net asset value is basically the total value of the stock or bond portfolio divided by the number of shares held by investors.

A qualified professional appraiser must perform the fair market value appraisal process. Based on the various factors outlined above, the appraiser will generally assign an FMV to the alternative investment that is less than its NAV.

Rate

Trustee fees, management fees, and escrow fees are generally charged based on the “value” of an account. The net asset value (NAV), or historical cost value, can overvalue the account and cost additional fees. Fair market value can reduce fees to a more realistic amount.

Last conclusions

Alternative investments, such as notes, offer potential advantages from an investment perspective as well as potential tax advantages. The ability to use FMV in income and estate tax planning, instead of the typically higher NAV, isn’t a gimmick or sleight of hand: it’s what the IRS requires.

It usually turns out that the FMV is lower than the NAV for an investment; that works in favor of taxpayers.