As of the end of March 2024, IRA assets exceeded $14 trillion—nearly twice the amount held in 401(k) plans—but only a small fraction of this IRA amount is held in self-directed IRAs (SDIRAs). There may be several reasons for this. First, most IRA assets are held in traditional depository financial institutions, which may offer only time deposit investments. Next, there aren’t many financial organizations that are equipped to allow self-direction and experienced enough to do it right. And last, many IRA owners simply do not understand the self-directed IRA concept, or perhaps they don’t know that SDIRAs exist. These reasons, and others, may explain why some retirement savers have not taken advantage of the many benefits that accompany an SDIRA. A quick refresher on the differences between “regular” IRAs and SDIRAs may help.
Self-Direction Allows Investing in Alternatives
The phrase “regular IRAs” in this article refers to IRAs that are maintained at depository institutions (e.g., banks, credit unions) or with firms that allow mutual fund investments (such as broker-dealers). Self-directed IRAs are usually maintained at a regulated financial organization that specializes in SDIRAs, such as a trust company. But for our purposes here, the big difference between regular IRAs and SDIRAs is the type of investments that they hold. While regular IRAs hold certificates of deposit (CDs) and possibly mutual funds, SDIRAs may invest in anything that federal law permits. (For example, IRAs cannot hold collectibles or life insurance.) Because these investments are not the typical choices for most IRA owners, they are often called “alternative investments.” Historically, alternative investments tend to fare well despite market volatility. If you’re looking to strengthen your retirement portfolio against times of financial uncertainty, you may want to consider diversifying your portfolio with a variety of alternative investments through an SDIRA.
Through the years, the most common types of SDIRA alternative investments include:
- Private equity (start-up company stock, hedge funds, etc.)
- Private debt (e.g., mortgage notes and other promissory notes)
- Real estate (residential and commercial rental property, raw land, etc.)
- Public investments (e.g., publicly registered companies not traded on a major exchange)
- Precious metals (gold, silver, platinum, and palladium bullion and certain coins)
The Benefits of Alternative Investments
The basic IRA concepts are straightforward. Traditional IRAs may give you a tax deduction up front, and then distributions and earnings are taxed when the assets are distributed. Roth IRAs are not deductible, but all the earnings are potentially tax free if distributions happen only after the Roth IRA owner is at least age 59½ and has had a Roth IRA for at least five taxable years. Similarly, investment concepts are not overly complex. IRA owners want to earn as much as possible to take advantage of either tax-deferred or tax-free gains, while minimizing the possibility of losing money.
Using alternative investments in your SDIRA can yield impressive results, often when more traditional investments, such as mutual funds, seem to reflect less favorable market conditions. Historically, alternative investments have performed well even during market volatility. If you're looking to bolster your retirement portfolio against financial uncertainty, consider diversifying with a range of alternative investments through an SDIRA. Here are just a few of the possible benefits of using alternative investments as part of your retirement portfolio.
- Diversification – Certain alternative investments may have a negative correlation to other, more common, investment choices. This may allow you to create a hedge against investment risk that other options can create.
- Numerous investment options – Aside from several categories that the IRS specifically prohibits, SDIRA owners may invest in any permitted option. This may allow individuals to use their unique expertise (e.g., in real estate) to identify and obtain the most suitable investments.
- Opportunities for growth – Some alternative investments can generate substantial income while appreciating in value. Although such investments are typically more complex than traditional ones, they may be well worth considering.
Any alternative investment—in fact, any investment—involves some risk, even if that risk entails missing an opportunity by being too conservative. But by implementing a thoughtful plan and using sound advice, you may find that adding alternative investments to your retirement investment lineup could be a smart decision.
The Bottom Line
This brief discussion will not give you all the details you need to make a wise decision about whether to self-direct some of your IRA investments. But it should give you some food for thought. Retirement plan investing doesn’t have to be needlessly complicated. As always, you should carefully consider any important decision such as this, preferably with the help of an experienced advisor. As you contemplate the best way to invest, keep in mind a few points:
- Self-directing your IRA into alternative investments can have a dramatic upside. Especially with the tax-free growth available with Roth IRAs, the right investments can produce enormous financial benefits.
- You can lose money. Alternative investments typically contain no guaranteed return and are not insured by the federal government. Investors should fully understand the potential risks of self-directing their IRA investments.
- You should work with experienced, competent professionals if you decide to self-direct your IRA investments. There are pitfalls, such as getting involved with prohibited transactions, that can derail your SDIRA. The right SDIRA custodian can help you identify and avoid such situations.
Establishing a self-directed IRA can provide you with the right mix of retirement assets to boost your savings and protect against economic downturns. For more details, see STRATA’s Which IRA Is Right for You? below or talk with one of STRATA's SDIRA experts to get started.
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