2023 is shaping up as a year that could turn into a recession. After the last two years of government stimulus and rocket ship-type asset values, the rocket ship is now falling back to earth. Just recently, billionaire investor Warren Buffett equated the stock markets to a “gambling parlor.”
- 2022 is on the verge of another recession
- Properly diversifying your portfolio is one way to mitigate the damage
- An IRA also affords one access to cash when it is needed
April 2022 was one of the worst months for the equity markets in the last fourteen years. Nasdaq fell a massive 13% in April 2022, the exchange’s worst monthly performance since the autumn of 2008, at the summit of the global financial crisis. The Nasdaq is now down 21% for the year, firmly in bear market territory. Whereas, the S&P 500 is off to its worst start to a year since 1939. Bitcoin has been even worse in April, down close to eighteen percent.
It’s conceivable that the equity markets will continue to fall in the short-term. Roughly 80% of S&P 500 firms have reported results and overall earnings growth is stumbling. According to FactSet, S&P firms are expected to produce earnings growth equivalent to a 7.1% gain year-on-year. That comes in below the five- and 10-year average.
Looking towards the second half of 2022 and into 2023, with the chances for a recession seemingly quite real, what can a Self-Directed IRA investor to do to better protect their retirement assets? The good news is that if one already has a Self-Directed IRA, he or she most likely appreciates the importance of investment diversification. However, for those IRA or 401(k) plan investors looking to gain more investment diversification for their retirement account, the following will discuss the most popular alternative investment options.
A well-diversified retirement portfolio is an important strategy to help prevent serious losses during a recession. Investing in non-traditional assets, such as real estate, offers a form of investment diversification from the equity markets. In general, the more diversified your portfolio, the better your assets will perform during a recession.
Most retirement account investors are not even aware that one can invest their retirement account assets can invest in alternative assets, such as real estate and gold. The IRS only imposes a few small limitations on the types of investments that can be made using IRA funds, which are life insurance, collectibles, and certain self-dealing and conflict of interest transactions under Internal Revenue Code (IRC) Section 4975. Investing retirement funds in hard alternative assets, such as real estate, is seen as a way of diversifying against a recession or a period of equity market instability.
Related: Why Invest in Alternative Assets?
Housing is a basic need for just about everyone. People may hold off on buying a new watch or a new boar during a recession, but it would be quite unusual for someone to elect to be homeless. Real estate provides Self-Directed IRA investors with the ability to invest in a hard asset that can produce cash flow (rental income) as well as appreciation. Plus, with an IRA, all income and gains from the real estate investment will flow back to the IRA without tax. This is known as tax-deferral.
In times of financial hardship, such as a recession, residential real estate is seen as more stable than commercial real estate, The COVID-19 pandemic has served as a blueprint of why commercial real estate does not perform as well as residential real estate during a period of financial hardship. The case for residential real estate during a recession is as follows: individuals and families are not going to move out on the street because of tough financial times. But when the Italian restaurant in the neighborhood can’t sell enough pasta and veal parmesan because people are watching their finances, the restaurant can simply close.
Unlike the stock market, which seems to go up and down like a roller coaster without much rhyme or reason, real estate, for comparison, is easier to understand. Real estate is quickly becoming a conventional asset investment class for many Americas. It is a physical asset that one can see and touch which offers many investors comfort in contrast to stocks.
Gold tends to outperform stocks in times of economic turmoil, data shows. For example, during the Great Recession, the value of gold increased dramatically, surging 101.1% from 2008 to 2010, according to a report from the Bureau of Labor Statistics. In other words, history has shown as that when stock markets go down, investors turn to precious metals, such as gold and silver, as security.
The IRS pursuant to IRC Section 408(m) allows a Self-Directed IRA to invest in pure gold, silver, and palladium bullion, plus bullion coins, American Eagle, and state minted coins. All precious metals owned by a retirement account must be held in the physical possession of a United Stated depository.
Cash is King
Cash is often deemed the safest asset class during a recession. A dollar has the same value in good times and bad. Cash will always outperform equities in a down market. On the flip side, if one ends up holding too much cash during a bull market, the cash will not earn any returns.
In addition to rental real estate, which generates cash flow from the underlying assets, an investor can use his or her IRA to access cash in the following ways:
Taxable Distribution: One with a pretax IRA can take a distribution at any time. However, there are taxes to be paid. Further, an additional 10% penalty applies if the IRA owners is under the age of 59 1/2. Those under that age should seek alternatives first.
Roth IRA distribution: A Roth IRA owner who is over the age of 59 1/2 and has had the Roth IRA funded for at least five years, is able to take a tax-free distribution. However, if either one of these conditions are not met, you will owe taxes and the early withdrawal penalty, if applicable. This Roth distribution can be used for any purpose, which could prove extremely helpful during a recession.
In addition, any and all contributions made to a Roth IRA can be taken as a tax-free distribution at any time. Earnings from the plan can only be distributed tax-free from the plan if the conditions above are met.
Keep in mind, the Roth IRA is arguable the most powerful type of retirement account, since no taxes are due on qualified distributions. One should be super cautious before electing to take a Roth distributions, especially if it is not qualified.
60-Day Rollover: An indirect rollover allows an IRA owner to take possession of his or her IRA funds for a period of 60 days and use the funds for any purpose. The 60-day indirect rollover can only be used once every twelve months. For some savers, gaining tax- and penalty-free use of IRA cash for those 60 days could prove to be useful, especially during a recession where cash flow issues are generally amplified.
Just remember, that the IRA funds must be contributed to a retirement plan within that timeframe. Once you exceed 60 days, any funds not returned would be treated as a taxable distribution.
Read More: Investing in Yourself with Retirement Funds
The general consensus is that in a period of financial difficulty, equities decline in unity. For example, in the 2008 financial crisis, the S&P 500 fell by more than 38% and most equity categories fell. However, in market downturns, including the 2008 financial crisis, some industries drop less than others. Typically, sectors such as consumer staples and utilities, have performed better than more volatile sectors, such as technology. For example, consumer staples were up 1.2% in the dot-com crash and down 28.5% in the 2008 financial crisis, a better performance than the S&P 500.
The 2008 financial crisis and the outset of the Covid-19 pandemic has provided us with an outline on how to protect one’s retirement assets during a period of financial instability. Diversification is the key. Using a Self-Directed IRA to invest in alternative assets, such as real estate or gold, or safer equities, is an important strategy to help protect your retirement assets during a recession.
In addition, having an IRA (or Roth IRA) offers several options for cash-flow issues, either long-term (distribution) or in the short-term (60-day rollover).
There is always a light at the end of the tunnel. You can ensure that light is not an oncoming train by utilizing the strategies outlined above.