Self-Directed IRAs Offer More Risk, Reward
By Jordan Sheppherd
Investors who contribute to an Individual Retirement Account (IRA) typically invest their funds in a combination of stocks and bonds, often using index funds for ease of maintenance. However, a smaller group of investors have emerged in recent years that use “self-directed” IRAs to diversify their portfolios. With the “self-directed” IRA, investors can buy real estate, precious metals, and even get involved in venture capital opportunities. However, these alternative IRAs are not for everyone. There are substantial taxes and penalties if you don’t follow Internal Revenue Service guidelines and some of the investments are risky.
One strategy to take advantage of alternative investments while minimizing risk is to diversify. Many advisors recommend no more that 15-20 percent of assets in alternative funds, with the rest in a mix of stocks and bonds. Additionally, another way to minimize risk and unexpected surprises is to understand the investment. Many alternate investments lack the transparency of publicly traded securities and, therefore, the onus is on the investor to more fully investigate these investments.
As with any investment vehicle, it is essential that you understand the Internal Revenue Service rules. There are restrictions on what can be held in an IRA and with how you can use the funds and investments. For example, the rule against self-dealing prevents you from buying real estate with your IRA and renting it to, say, a parent. The penalties for such transgressions are substantial. Know the rules ahead of time and prevent unexpected surprises.
There are specialty financial firms that offer guidance on how to set up and administer “self-directed” IRAs, though they generally do not advise on the investments themselves. If you embrace the route of a “self-directed” IRA, be sure to do your research, consult with both an attorney and financial professional, and consider diversification as a path towards minimizing your risk.