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Why Investing in Alternative Assets Makes Sense in a Self-Directed IRA

Why investing in alternative assets makes sense in a self-directed ira

The bull market for stocks is now 10 years old, having bottomed out in early March of 2009 in the wake of the financial crisis. While the direction of the market has been generally up over the past decade, this won’t last forever. The use of alternative asset classes can help diversify your portfolio for the inevitable market downturn as well as the normal ups and downs in the stock market over time.

Low correlations 

Many types of alternative investments have relatively low correlations to traditional asset classes like stocks and bonds. Investing experts have long suggested constructing your portfolio to include some investments with low correlations to other portfolio holdings.

Alternatives like private debt and real estate all traditionally have low correlations to more traditional asset classes.

Examples of alternative investments

There are many types of alternative investments that investors can consider. Some examples include:

•  Real estate
•  Hedge funds
•  Commodities and futures
•  Private equity investments
•  Private placements
•  Private corporate debt instruments
•  Real estate notes and trust deeds
•  Crowdfunding and startups
•  Structured settlements

Why invest in alternatives inside of a self-directed IRA?

In the realm of financial planning, the term “asset location” is often used in the context of holding investments in either a taxable account or in a tax-deferred retirement account. This thought process can also carry over to include investments in alternative asset classes.

Investors interested in these and other types of alternatives have choices as to what types of accounts that can be used to make these investments. They can be made using taxable funds. This might be considered the most “normal” method of investing in alternatives. But this might not always be the best location for these types of assets.

Investing in alternatives inside of an IRA via a self-directed account can make a lot of sense for several reasons.

Where the money is

Many investors have a high percentage of their investable assets held inside of retirement accounts. For many, this means their IRA account. With people changing jobs numerous times over the course of their careers, retirement funds are often rolled over from workplace retirement plans like a 401(k) to an IRA account. These retirement account balances can account for the largest pool of investable funds for many investors.

Liquidity and time horizons

Many alternatives are less liquid than traditional investments like stocks, ETFs and mutual funds. Those vehicles have an ongoing secondary market and can be sold on a daily basis at a publicly available market price. Investors have access to their funds quickly. For many of the alternatives listed in the section above, liquidity can vary.

For example, hedge and private equity funds have set time periods when investor funds can be accessed. Real estate is also not an asset that can generally be sold quickly. The lack of liquidity can dovetail with the longer time horizons that many investors have until they will need the funds from their IRAs for retirement. Additionally, using money inside of a self-directed retirement account means that you won’t need to tie up taxable money in illiquid investments that may be needed for other purposes.

Tax issues

Capital gains and other types of investment income are taxable if held in a taxable account. Income on investments held inside of a retirement account are tax-deferred (or tax-free in the case of a Roth). Income from investment real estate or from a private debt investment will stay inside of the account untaxed. These funds are available for additional investment opportunities, both in alternatives and in traditional investments.

Some alternatives have complex tax rules and holding these assets within an IRA can help investors avoid some of these issues.

Holding investments in start-ups inside of an IRA can help defer taxes over time if the investment is structured correctly. There are a number of angel investors who have been able to legally defer taxes on outsized gains on their investments in startups by using an IRA.

Using a self-directed IRA to invest in alternative investments provides another level of diversification for investors for their retirement funds and for their overall portfolio. In a market environment where performance faces headwinds from factors such as trade wars and interest rate uncertainty, investing in alternatives via a self-directed IRA can provide investors with an edge in an uncertain environment.

If you have questions about self-directed IRAs, you can contact us at 866-928-9394 or Service@StrataTrust.com.

Tags: all things retirement, alternative investments, IRA, IRA investments, retirement, Roth IRA, SDIRA, self-directed ira, SEP IRA, Traditional IRA, types of IRA

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