While many people are content to leave their retirement assets in a managed 401k or IRA, there are non-traditional places to invest funds that can enhance returns, increase diversity, and control for volatility. These are referred to as “Alternate Asset Classes”. These methods typically require the creation of a Self-Directed IRA, since funds need to be in the investor’s control rather than in a retirement account.
What’s a Self-Directed IRA? In 1996, a landmark court ruling commonly referred to as the Swanson Decision(1) spawned the creation of the “Self-directed”, or “Checkbook” IRA. Not to be confused with a Rollover IRA, this is the stepping stone to entering the world of alternative investments. It’s essentially a bank account with a checkbook where you can make selected investments. The IRS categorises it as a ROBS (RollOvers as Business Start-ups)
How do I fund one? Self directed IRAs have the same funding limitations as regular IRAs, so you can make a direct contribution of $5500 in 2014 if you’re under 50, $6500 if over 50. You cannot deposit more than your total limit to both the normal and self-directed IRA, however you can rollover funds from other retirement assets. That seems to be the most common method people use to fund these plans.
Here are some of the more common alternative investment classes:
- Buy into a small business/equity
- Hedge Funds (short/neutral/long)
- Managed Futures
- Private Equity
- Real Estate/REITs
- Venture Capital
- Offering private Loans
One of the most common ways to take advantage of this investment class is to purchase income producing real estate. While you may not be comfortable holding REITs since the market has been so volatile, if you purchase a rental property, you can reasonably expect guaranteed income from your renter, along with the increasing value of the rental property.
In several upcoming articles, we’ll describe several of these investment vehicles in more detail. But for the time being, the best advice is to consider alternative investments only if your primary portfolio is already in good shape, and you want to diversify into something that requires you to take a more active approach to managing the asset.
It’s important to understand that significant potential risk comes along with the freedom of these plans. There is a thriving business of investors that serve as custodians. Since many investment brokers make their salaries based on assets managed, they see self directed IRAs as a huge potential market, and consequently hard sell. Buyer beware!
Investing in alternative asset classes can be fraught with risk, so don’t dive in lightly. Make sure you understand the challenges and time requirements associated with this class. Unless you know what you’re doing, this is best left to professional financial planners.