Traditional assets, such as stock, mutual funds, and ETFs are by far the most popular investment option for IRA owners. With over 60 million IRAs worth approximately $12 trillion dollars, it is estimated that between 90%-95% of IRA assets are invested in traditional investments. The primary reason for this is that the largest financial institutions, such as Fidelity and Vanguard, only allow IRA investors to invest in traditional assets. The reason – like almost everything comes down to money. Financial institutions make money from selling traditional investments; they do not make money from allowing IRA owners to buy real estate and other alternative assets.
What is an Alternative Asset?
Alternative assets typically refer to investments that are not considered traditional asset classes frequently targeted by most IRA investors, such as stocks, bonds, or cash investments.
The most popular type of traditional investments are publicly traded investments in these types of asset classes. The common method of investing in traditional assets is through public markets, where companies sell shares to the general public via stock exchanges, such as the NYSE and NASDAQ.
On the flip side, alternative asset investments include real estate, private equity, venture capital, hedge funds, cryptocurrencies, precious metals, private placements and many other non-traditional investments. Due to their non-traditional nature, alternative asset investments may be less liquid than their traditional counterparts and may require a longer holding period before a capital event is realized.
Why Invest in Alternative Assets?
There are many important reasons to invest one’s IRA funds in alternative asset investments. Below are the most popular reasons millions of IRA owners have allocated some or all of their IRA funds to alternative assets.
Diversification
Investing one’s IRA funds in alternative assets, such as real estate offers an IRA owner the ability to diversify their retirement assets from being exclusively invested in the equity markets. Any good financial advisor will tell you that, the more diversified your IRA portfolio is, the greater chance that your IRA assets will offer lower correlation, meaning they are less likely to move in the same direction.
2022 has turned into a very rough year for the equity markets. April 2022 was the worst performing month for the NASDAQ since the fall of 2008. Having the opportunity to diversify your IRA assets by investing in alternative assets and not be invested exclusively in equity markets will help protect your IRA assets from steep losses from a falling equity market.
Sleep Well at Night
A growing majority of IRA owners have become disturbed with the volatility and unpredictability of Wall Street. The performance of the stock markets in 2022 have left many IRA owners frustrated and anxious from the turbulent markets. For many IRA owners, alternative assets feels safer and easier to comprehend.
Over the last several years, real estate has become viewed as a safe and trusted asset class for millions of Americans. Real estate is a tangible asset that one can see and touch. That aspect makes it the most popular alternative asset for IRA investors. Real estate investing still involves some risk. Although, many IRA investors feel safer investing in a tangible asset that can generate cash flow as well as appreciate over time.
See & Touch What You Own
Many alternative assets, such as real estate and precious metals, are tangible hard assets that an IRA owner can see and touch. With real estate, for example, an IRA owner can drive by the home owned by the IRA at any point and see it, which provides a sense of calm to many IRA investors, especially during a period of equity market instability.
You can’t exactly go down to the bank and hold your stocks in your hands!
Related: Alternative Assets to Fight Inflation
Advantage of Investing in Alternative Assets with an IRA
A Self-Directed IRA is the most popular vehicle for retirement account holders to invest in non-traditional assets, such as real estate or an emerging asset category, such as cryptos. It allows one to purchase hard assets, which is seen as a good hedge against inflation or a falling stock market.
A popular reason many IRA investors look to invest in alternative assets using retirement funds is the tax concept of deferral. Under the doctrine of tax deferral, all income from the sale of an alternative asset would flow back to the retirement account without tax. When an IRA makes an investment, all gains generated by a pretax IRA investment flow back into the IRA tax free. This is known as tax deferral. Tax deferral permits your IRA assets to grow at a much faster pace than if the funds were held personally, allowing you to build for your retirement more quickly.
For example, if one started making $5,500 annual IRA contributions from age forty to seventy assuming an 8% annual rate of return, the IRA owner would have $722,325 at age 70. Whereas, if the individual used personal funds instead of IRA funds to make the same contributions and investments, assuming a 25% tax rate, the individual would have just $465,311 at age 70. In the case of tax deferral, numbers don’t lie.
Conclusion
The 2008 financial crisis taught many of us that a well-balanced and diversified IRA portfolio is key to surviving a period of financial instability. 2022 is turning into a disaster of a year for the traditional equity markets. Exploring the world of alternative assets will be crucial for many IRA investors seeking to protect their IRA assets from large losses.
The IRS only provides a very narrow list of investment types that are not permitted to be held by an IRA, such as life insurance, collectibles and certain transactions involving a disqualified person.
Alternative assets are permitted to be held by IRAs because the IRS understand the benefits of doing so. Investment diversification, hedge against inflation, and investment options are seen as the most popular reasons why IRA investors seek to explore the world of alternative assets.
