Alternative assets are the fastest growing segment of the retirement market. An alternative asset is an investment that isn’t among traditional asset classes, such as stocks and bonds. These investments are more common and well-known. For example, many investors know the ins and outs of real estate, but can’t navigate the intricate world of Wall Street. This is one reason alternative asset investments have become increasingly popular. The second reason arose from the 2008 financial crisis.
You can invest in alternative assets with a Self-Directed IRA (SDIRA). A Self-Directed IRA is a type of individual retirement account (IRA) that gives you, the investor, control over your investment decisions. With the SDIRA, you can diversify your portfolio through alternative assets. Now, you can invest in real estate, private business, tax liens, cryptocurrency and more. The structure of a Self-Directed IRA is similar to that of a traditional IRA and a Roth IRA. The primary objective is to save for retirement and you have a specific age requirement for withdrawals. However, the differences lies in what types of assets these accounts hold. With a SDIRA, you have a wider range of investments to make. While you can make alternative investments, you still have the liberty of making traditional investments.
Self-Directed Retirement Plan Companies
Walk into a financial institution, such as Fidelity, and ask to set up a Self-Directed IRA. It’s unlikely that the institution will allow you to open a Self-Directed retirement account because they don’t make money this way. In other words, when you withdraw your funds and invest in a third-party for alternative assets, they gain no financial benefit from this transaction. Financial institutions make their money by selling the products and services that only they provide. However, you will have great success opening your SDIRA at a company that specializes in Self-Directed retirement plans, like IRA Financial Trust. These companies serve as the Custodian of the Self-Directed IRA investments, and its specialists can often ensure that you don’t violate IRS (Internal Revenue Service) regulations.
Investing in Alternative Assets
So, why are many retirement investors looking to use some or their retirement funds to make alternative asset investments? Here are the 4 main reasons:
In general, most Americans have an enormous amount of financial exposure to the equity markets. Whether it is through retirement investments, such as IRAs or 401(k) plans, or personal savings, many of us have most of our savings connected to the stock market. In fact, over 90% of retirement assets are invested in the financial markets. With over $30 trillion in retirement assets as of 2018, you can see the scope of that exposure. Investing in non-traditional assets offers a form of investment diversification from the equity markets.
Additionally, the more diverse your portfolio, the greater chance that your assets will offer lower correlation. In other words, they are less likely to move in the same direction. However, diversification does not assure profit or protect against loss. Nevertheless, the use of non-traditional asset classes can help protect your portfolio when the market is down. It can also help protect you from losing more than the market.
2. Invest in Something You Understand
Many Americans became frustrated with the buoyancy of the equity markets. Many Americans have yet to recover from the market swings and they aren’t 100% sure what goes on in Wall Street or how it all works. Real estate, for comparison, is often a more comfortable investment for the lower and middle classes. You may relate. You most likely grew up with the understanding of such investments. Whereas the upper classes learn about Wall Street and other securities during their younger years and college days.
We all hear talk about the importance of owning a home or the amount of money that you can make by owning real estate. Reality TV related real estate programming is growing in popularity, and this is contributing to real estate becoming a mainstream asset category. It’s also rising as one of the most trusted asset classes for Americans. Of course, it isn’t without risk, because there are no risk-free investments. However, many retirement investors feel more comfortable understanding the real estate market and buying and selling real estate than they do stocks.
3. Inflation Protection
Rising food and energy prices, along with high federal debt levels, have recently fueled new inflationary fears. As a result, some investors may look for ways to protect their portfolios from the ravages of inflation. It is a matter of guesswork to estimate whether these inflation risks are real. However, for some retirement investors, protecting retirement assets from inflation is a big concern. Inflation can have a negative impact on a retirement portfolio because it means a dollar today may not be worth a dollar tomorrow. It also increases the cost of necessities that are vital to live and enjoy life, such as bread, gas, shelter, clothing, medical services, etc. This decreases the value of money so that goods and services cost more.
For example, if someone has an IRA worth $150,000 at a time of high inflation, that $150,000 will be worth significantly less or have significantly less buying power. This can mean the difference between retiring and working the rest of your life. Buying hard assets are seen as one way of protecting your assets against inflation. Many investors recognize that investing in commercial real estate can provide a natural protection against inflation. As you may know, rent tends to increase when prices increase. This acts as a hedge against inflation.
4. Hard Assets
Many alternative assets, such as real estate and precious metals are tangible hard assets. In other words, you can see and touch them. With real estate, for example, you can drive by with your family, point out the window, and say, “My IRA owns that”. For some, that’s important psychologically. This is especially the case in times of financial instability, inflation, or political or global upheaval.
Alternative Assets and Tax Benefits
In addition to the four main reasons investors are looking to use a SDIRA to make alternative asset investments, the tax benefits may be the most attractive.
Tax deferral literally means that you are putting off paying tax. The most common types of tax-deferred investments include those in IRAs or Qualified Retirement Plans, like a 401(k). Tax-deferral means that all income, gains, and earnings, will accumulate tax free until the investor or IRA owner withdraws the funds. As long as the funds remain in the retirement account, they will grow tax-free. This allows your retirement funds to grow at a much faster pace than if the funds were held personal. As a result, this allows you to build for your retirement more quickly.
Additionally, when you withdraw your IRA funds in the form of a distribution after you retire, you’ll likely be in a lower tax bracket and be able to keep more of what you accumulated. So, with using a Traditional IRA as a retirement savings vehicle, not only are you not paying taxes on the money you invested, you could be paying them at a lower rate when you finally “take home” your money. In other words, as long as the funds remain in the account, they grow without taxes eroding their value. This enables assets to accumulate at a faster pace. This gives you an edge when saving for the long term.
A Roth IRA will allow a retirement account holder to generate tax-free growth in their Self-Directed Roth IRA. All income from the Self-Directed Roth IRA or Roth 401(k) plan will be exempt from tax. However, the Roth account must be open for five years and the Roth account holder must be over the age of 59 1/2. Under these rules, you pay no tax on the distribution amount. That means you can invest in alternative assets, such as real estate and cryptocurrencies, and never pay tax on any of the gains.