Alternative assets are investments outside of traditional investments. Common examples of alternative investments include real estate, private equity, cryptocurrencies, precious metals, such as gold, structured settlements, and venture capital investments. Whereas traditional investments include stocks, bonds and bank CDs.  Alternative investments are more complex than traditional investments, which is why they appear to be better suited for “accredited” or “qualified” investors.

“[Alternative] investments…just do not trade like a simple stock and have much more complexities,” explains Gerald Hendrik, Director of New Business and Client Relations at International Management Corp (ICMC), a wealth management firm. “Alternative investments are geared to…investors who are considered high net-worth individuals with investment experience.”

Hendrik goes on to say that alternative investments generally have high minimum investment requirements. However, you do not need to be an experienced investor to purchase alternative assets with your retirement funds. It is important to understand the investment and preferably have background knowledge before making a commitment. It’s also important to know the benefits and the dangers of the investment(s) before putting money into it.

What are the Benefits of Alternative Assets?

As with any investment, there are risks when using retirement funds to purchase alternative assets. Hendrik recommends investing indirectly for individuals who are just starting out, such as REITs (real estate investment trusts) or mutual funds that include alternative assets, like real estate, natural resources, private equity and more.

“If you directly invest in real estate you are required to do all the heavy lifting and research on your own,” Hendrik says. “That can leave a lot of room for mistakes unless you are a professional in that field.”

Hendrik also suggests consulting with a trusted professional that is a fiduciary. A professional can help determine which alternative investment is a good fit, and investments to reconsider.

Investing in alternative assets is a smart strategy, and if you haven’t started, now is the time. Consulting with a wealth management company, such as ICMC, is a good way to overcome risks, as they combine wealth management tools with proprietary tools. You will navigate the finance landscape with a professional by your side, which may offer peace of mind.

Related: How to Save More for Retirement

Why should you invest in Alternative Assets?

The importance of investing in alternative assets comes down to investment diversification. Diversifying your retirement portfolio with US equities, as well as alternative assets is a risk mitigation strategy. For example, if the U.S. stock market takes a hit, you can fall back on your real estate, cryptocurrency or precious metal investments.

“Alternative investments are becoming very popular,” Hendrik says. “They offer the potential for higher returns and they have lower correlations to traditional investments.”

When your investments do not correlate, they can protect your portfolio from market volatility. Every investor should look into purchasing both traditional and alternative investments.

“Growing wealth is the goal,” says Hendrik, “but protecting it is just as important.”

Read More: What is a Self-Directed IRA LLC with Checkbook Control?

How can you invest in Alternative Assets?

Investors who are interested in using their retirement funds to invest outside of “conventional” investments can do so with a self-directed retirement plan. Before establishing a self-directed account, such as the Self-Directed IRA, make sure you go through a custodian who allows for the purchase of alternative investments. For example, most banks and financial institutions will establish a “Self-Directed” plan and make investments on your behalf. However, the types of investments such institutions will make are restricted to the financial products they sell conventional/traditional investments.

If you wish to you use your retirement funds to purchase real estate, cryptocurrency, tax liens or any other alternative asset, you would not be able to do so through a bank or financial institution. The reason for this is because banks and financial institutions do not make money when you purchase assets they do not sell. Unfortunately, they are completely within their right not to allow you to invest in such assets.

Passive Custodian

Even though the majority of banks and financial institutions do not allow investors to invest in alternative assets, you can still make alternative investments with a passive custodian.

By establishing a Self-Directed retirement plan through a passive custodian, also known as a Self-Directed IRA custodian, you will gain the freedom to make any type of investment. Passive custodians administer retirement accounts and offer custodial and administration services. They do not make money on the type of investments you purchase with your retirement funds because passive custodians do not sell financial products.

We will soon look at the retirement vehicles that allow you to make alternative asset investments.

Self-Directed IRA or Solo 401(k) Retirement Plans

At IRA Financial, we are the fastest growing provider of self-directed retirement plans. Our plans include the Self-Directed IRA and the Solo 401(k) plan that allow plan participants to invest in traditional and alternative assets tax-deferred or tax-free in the case of a Roth IRA or Roth 401(k). By establishing checkbook control, you can make investments without custodian consent, which eliminates custodial fees and delays.

Self-Directed IRA

A Self-Directed IRA is an individual retirement account that has the same characteristics as a Traditional IRA, but allows investors to make alternative investments with their retirement savings. In the last several years, the number of Self-Directed IRA accounts have grown significantly.

Solo 401(k)

A Solo 401(k) is a traditional 401(k) plan that covers only one employee. In order to be eligible for the plan, you must be self-employed or have a small business with no full-time employees other than yourself, business partner(s) or spouse. The business can be a sole proprietorship, corporation, LLC, etc., but the income it generates must be from a trade or business.

Note: A full-time employee is an employee who works less than 1,000 hours in a year.

The maximum contribution limit for a Solo 401(k) in 2022 is $61,000 ($67,500 if age 50 and over). This is the combined contribution of the elective deferral and profit-sharing contribution types. (Click here for current contribution limits.) Again, when you make investments with the Solo 401(k), the income and gains the investment generates will be tax-deferred until you take a qualified distribution. Learn more about the Solo 401(k).

What are the prohibited transaction rules?

You can engage in virtually any investment with a self-directed retirement plan, but IRS rules do exist. For example, you cannot use retirement funds to purchase life insurance or collectibles (works of art, stamps, some coins, etc.). Furthermore, you cannot engage in a transaction that involves a disqualified person, which includes yourself as the Self-Directed IRA owner/ Solo 401(k) trustee.

“You can possibly get tax advantages or sheltered cash flows with alternative investments if done properly,” says Hendrik. “However, if you invest in alternatives in the wrong account or incorrectly, it can have negative consequences.”

Hendrik advises that investors consult with a professional before investing. At IRA Financial, our team of tax and ERISA specialists are onboard to help you navigate the IRS prohibited transaction rules. By working with IRA Financial, we will ensure that your self-directed retirement plan remains IRS compliant. Unlike other custodians, IRA Financial has never had a client audited by the IRS for triggering a prohibited transaction.

Wrapping it up

Alternative investments are becoming more popular, and while they may have higher risks than traditional investments, that translates to higher rewards. More importantly, by diversifying your retirement portfolio with traditional and alternative investments that have a low correlation, you will protect your hard-earned funds if one market crashes or in the event of a recession.

“Like any investment there are going to be risks involved,” Hendrik says. “There are many types of risk…Diversification is key so that one market crash or recession does not wipe you out. “