Alternative investments have been allowed within IRAs since the 1970s, when they were first introduced, but most companies have focused on stocks, bonds and mutual funds. As the markets continue to fluctuate, more investors are turning to options they can fully control themselves, like self-directed IRAs and solo 401(k)s.
Adam Bergman, a tax attorney and partner at IRA Financial Group in New York and Florida, says that interest in self-directed retirement account options has “exploded in popularity” the past few years. He believes they are getting more notice now because people began looking for alternative ways to invest after the 2008 stock market decline.
“People aren’t as comfortable having all of their retirement fund in stocks or Wall Street. They are looking to diversify with gold, real estate, peer-to-peer lending or investing in a friend’s business,” he said.
Another reason they’ve become popular is because of Mitt Romney, Bergman said. Since Romney announced he was running for president, there has been a lot of publicity about how he boosted his own IRA into the millions by investing in Bain Capital deals. There also has been talk about him allowing his company’s employees to co-invest in Bain Capital’s deals through a special low-cost share class that ended up returning huge gains for those who participated.
“That spurred people’s interest over the last year,” Bergman said.
He added that “with the recent downgrade of the U.S. credit rating, people are scared of inflation and looking to buy hard assets like real estate and gold. It has led people to these types of investment opportunities and structures.”
There are more than 45 million IRAs in the United States, and one million 401(k)s holding $13 trillion in retirement account assets, Bergman said. “Thirty-five percent of all American savings is tied up in retirement accounts. There’s a lot of money out there. What I’ve heard is that 92 percent of people or higher invest strictly in the stock market, mutual funds and bonds,” he said. That means that the potential market for alternative investments, like real estate, is very high.
The Entrust Group, which offers self-directed retirement plan services, says on its website that the self-directed industry is growing very fast and is expected to see around $2 trillion enter the market in the next two years. “There are over 45 million retirement account holders, and less than 4 percent of those are held in nontraditional assets,” the site states. “This number is expected to grow significantly over the next five years as more individuals and their financial advisors attain a greater awareness of self-directed IRAs.”
What is a self-directed IRA? It is a retirement account in which the contributor picks all of the investments himself. Stocks, bonds and mutual funds are still the most popular investments in self-directed accounts, but self-directed options allow investors more flexibility to invest in different opportunities, like real estate, precious metals, private placements and peer-to-peer lending.
So should everyone run out and open up a self-directed account? According to Bergman, self-directed accounts aren’t for everybody. “People need to know what they are doing like for any investment,” he said. People have the opportunity to invest in real estate as part of their accounts, but like any investment, the investors need to know something about buying and selling real estate before they get involved in real estate transactions within their portfolio, otherwise there are many unforeseen pitfalls.
“A self-directed IRA has more investment opportunities, but it also has a lot more opportunities to make bad investments,” Bergman said. “If you are buying things in the non-traditional sense, even gold and silver, make sure you know what you’re buying.”
The purpose of making some of the alternative transactions within an IRA is so that your investment returns grow tax free.
“Retirement accounts are one of the last great ways to take advantage of tax deferral. The real estate market as it is has seen a lot of drops in the last five years. Clients are looking at ways to take advantage of that. They perceive a lot of potential for appreciation, so they are using their retirement fund. [Their retirement accounts are] not performing well in the stock market, so they are diversifying into real estate,” he said.
Dean Schmitz, director of retirement and investor services for The Principal, said that his company’s representatives often hear from clients that they want to buy gold within their accounts, but every broker/dealer is different. Some allow alternative investments and some do not. The Principal’s broker/dealer does not.
He cautions that “the average investor should not get involved in [self-directed IRAs]. The average investor should be in a well-diversified portfolio. If they are looking at growth and market risk, we have target-date funds and target risk funds,” he said.
Target date and target risk funds target their investments either to the date people plan to retire or to the level of risk they want to take. “They are very well-diversified investments,” he said. Investors who aren’t savvy can get in trouble with a self-directed account because they may put all of their money into one or two stocks or precious metals and when those stocks or the price of the precious metals plummet, they are left with only half or one-third of their investments.
Schmitz encourages people to speak with a financial advisor no matter which direction they take.