Investors are often wary about putting their money into anything but traditional offerings like individual stocks, bonds and mutual funds: they are simply becoming more risk averse and turning to so-called “safer” investment“ choices.
Unfortunately, such “safer” choices can come with a history of lower and volatile returns.
Generally, these asset classes fall outside of the traditional stock market. Consequently, their movements are, generally, independently of conventional market forces.
“Correlation… does not tell you how risky any particular asset is, either. Financial goals, time horizons, the emotional ability to withstand losses, and other factors impact an investor’s risk tolerance…Thus, a portfolio designed solely to be well diversified from the standpoint of correlation without taking into consideration other factors may be completely unsuitable for many investors.” Charles Rotblut, CFA for Association of American Investors, June 2012
Two alternative investment options to consider for a self-directed IRA are outlined below. Each can bring that non-correlative feature to the portfolio.
The ‘private equity’ option…
Given today’s economic uncertainties, plus a low-interest rate environment, alternative investments can be a solid choice, particularly if accumulated inside a self-directed IRA. One of the many choices includes investing in a private equity firm that is not listed on one of the stock exchanges.
This choice may seem counter intuitive to the conventional way of investing, but it has its own rewards. For one thing, such private-party investments can add less volatility to the portfolio because investors can’t trade in-and-out of private equity funds at will. This fact alone smooths volatility, a trait not found in our stock markets where individuals institutions often buy-and-sell in seconds.
Normally, private equity company by offering Limited Partnerships (LP). These core private equity funds are set up to be long-term investments. The investor’s holding period is in place to reduce leveraging, or taking more positions ‘on margin, a common practice in the stock market.
The LP option assures more time for the money to grow without the gyrations we experience in the stock markets.
Real estate inside a self-directed IRA…
Purchasing income property through a self-directed IRA not only is an excellent way to protect cash flows from immediate taxation, but this method also allow more time for appreciation to accumulate, as noted on a Fox Business News overview regarding this topic.
The investor must, first, appoint a trustee, or custodian, who will be in charge of “holding” the IRA assets. They will also be tasked with carrying out prescribed administrative duties, including filing proper documents with the IRS.
Investors should also be aware that they can’t dip into the IRA until they retire. However, the IRA can be used to pay all expenses and taxes related to the rental. Maintenance costs, of course, must be paid out of the IRA, as well as insurance or any dues and professional memberships.
Moreover, if the investor chooses to sell his property before he retires, he is unable to access the gains inside the IRA until retirement.
In short, the account can’t be used like a “piggy-bank.” What’s more, every dollar taken out of the IRA must be approved by the trustee—or custodian. Consequently, it might make sense to use the services of a property manager to track and monitor expenses.
One caveat about this type of real estate IRA is that the investor can make tax- deductible contributions to it via the trustee; furthermore, if more property is purchased for the IRA, then any funds needed for cash down payments, for example, must come from IRA funds. In the latter case, the use of a rollover IRA might be accessed as well.
Contact us to learn more about using alternative investments in a self-directed IRA.