Adam Bergman

Beginner's Guide to Alternative Investments

Alternative Investments

Alternative investments have grown in popularity over the past ten or so years, but it's true that they aren't for everyone. Alternative investments are more complex in nature and illiquid when compared to traditional investments and, thus have historically been held by accredited investors whose annual income exceeds $200,000. This remains true with some investments like hedge funds and private equity funds, which are less accessible to small investors. But not all are limited to accredited investors, or difficult to access as a small investor. Many alternative assets are popular among investors because they are easier to understand than investments within the stock market. Furthermore, the rise of Cryptocurrency has helped alternative investments become more accessible to individuals, regardless of income.

What are Alternative Investments?

Alternative investments are assets outside of traditional/conventional markets, such as stocks, bonds, or mutual funds. Some popular alternative investments include real estate, which is often classed as an alt asset; cryptocurrency; and private business/placements. Because these investments do not move in the same direction as the traditional markets, they tend to perform better when traditional investments are down. Due to their lack of correlation, it is highly advised to ensure your investment portfolio isn't lacking in either investment type. This is the number one characteristic of alternative assets that makes them a good investment: investment portfolio diversity.

Here at IRA Financial, we see a broad range of alternative asset investments.  These range from the typical (real estate and precious metals) to the obscure (racehorses and dairy cows).  As long as it’s not prohibited by the IRS, you can invest in just about anything.  Prohibited investments include life insurance, most collectibles and those that involve a disqualified person.  By self-directing your retirement plan with a Self-Directed IRA or Solo 401(k) and even a Self-Directed Coverdell ESA or Health Savings Account, you too, can invest in alternate assets. The most common alternative investments individuals hold in retirement accounts include real estate, precious metals, private businesses, hard money loans, and Cryptocurrencies.

Real Estate

Easily the most popular alternate asset investment we see is real estate.  Real Estate investments can include commercial spaces, apartments buildings, raw land, fix and flips, etc.  From what we have seen, most people who invest in real estate with retirement funds have deep backgrounds in the business.  Ever since the housing bust of the mid 2000’s, the real estate market has been, for the most part, a solid investment.  Using a self-directed retirement account to invest in real estate is a great way to earn passive income, such as rental income, to build your nest egg.  The use of a Real Estate IRA has become one of the most popular ways to invest.

Precious Metals

Quite possibly the hallmark of alternative asset investments is precious metals.  Everyone knows how valuable gold, silver, platinum, and other metals are.  They’re generally a safe bet as well.  The reason being is that metals are not affected by inflation, they’re easy to convert into cash, they’re the go-to source during financial and political unrest and they can be invested in with ETFs, or exchange traded funds.  Further, metals are recognized and accepted all over the world.

Private Businesses

More and more people are looking at their retirement funds to invest in themselves.  By utilizing IRA Financial’s IRS-approved ROBS solution, you can use your 401(k), IRA or other account funds to invest in your own business.  Who doesn’t want to work for themselves?  The ROBS solution allows one to rollover current funds into a new 401(k) plan that will be used to fund your business.  If you are confident in your ability to start and run your own business, you should look into it.  That way, you control your own financial destiny (not the government or big business).  Check out our recent article about the Pros and Cons of ROBS!

Hard Money Loans

Hard Money Loans, also known as Peer-to-Peer lending, as become an increasingly popular alternative asset investment.  As you may know, traditional loans are becoming harder to obtain.  Further, the process can drag on for weeks.  Moreover, you need great credit and proof that you can pay off the loan.  What if you don’t meet the necessary criteria for a bank loan OR you need your money faster?  That’s where a hard money loan comes into effect.  One can use his or her retirement funds to lend you the money you need, regardless of credit, in a timely fashion.  Generally, these types of loans are used for real estate ventures.  The property is then used as collateral for the loan.

Cryptocurrencies

Believe it or not, cryptocurrencies are still a quite popular alternative asset investment. The most famous crypto, Bitcoin, has been on a wild ride since its inception. This hasn’t stopped investors’ belief that cryptos are an emerging market. Cryptos are not backed by any bank but instead, use technology as the driving force of digital currency. Obviously, this is the riskiest investment on this list. However, big risks can lead to big rewards. Just ask anyone who invested in Bitcoin early on!

Benefits of Alternative Assets

1. Diversification

In general, most Americans have an enormous amount of financial exposure to the equity markets. Whether it is through retirement investments, such as IRAs or 401(k) plans, or personal savings, many of us have most of our savings connected to the stock market. In fact, over 90% of retirement assets are invested in the financial markets. With over $30 trillion in retirement assets as of 2021, you can see the scope of that exposure. Investing in non-traditional assets offers a form of investment diversification from the equity markets.

Additionally, the more diverse your portfolio, the greater chance that your assets will offer lower correlation. In other words, they are less likely to move in the same direction. However, diversification does not assure profit or protect against loss. Nevertheless, the use of non-traditional asset classes can help protect your portfolio when the market is down. It can also help protect you from losing more than the market.

2. Invest in Something You Understand

Many Americans became frustrated with the buoyancy of the equity markets. Many Americans have yet to recover from the market swings and they aren’t 100% sure what goes on in Wall Street or how it all works. Real estate, for comparison, is often a more comfortable investment for the lower and middle classes. You may relate. You most likely grew up with the understanding of such investments. Whereas the upper classes learn about Wall Street and other securities during their younger years and college days.

We all hear talk about the importance of owning a home or the amount of money that you can make by owning real estate. Reality TV related real estate programming is growing in popularity, and this is contributing to real estate becoming a mainstream asset category. It’s also rising as one of the most trusted asset classes for Americans. Of course, it isn’t without risk, because there are no risk-free investments. However, many retirement investors feel more comfortable understanding the real estate market and buying and selling real estate than they do stocks.

3. Inflation Protection

Rising food and energy prices, along with high federal debt levels, have recently fueled new inflationary fears. As a result, some investors may look for ways to protect their portfolios from the ravages of inflation. It is a matter of guesswork to estimate whether these inflation risks are real. However, for some retirement investors, protecting retirement assets from inflation is a big concern. Inflation can have a negative impact on a retirement portfolio because it means a dollar today may not be worth a dollar tomorrow. It also increases the cost of necessities that are vital to live and enjoy life, such as bread, gas, shelter, clothing, medical services, etc. This decreases the value of money so that goods and services cost more.

For example, if someone has an IRA worth $150,000 at a time of high inflation, that $150,000 will be worth significantly less or have significantly less buying power. This can mean the difference between retiring and working the rest of your life. Buying hard assets are seen as one way of protecting your assets against inflation. Many investors recognize that investing in commercial real estate can provide a natural protection against inflation. As you may know, rent tends to increase when prices increase. This acts as a hedge against inflation.

4. Hard Assets

Many alternative assets, such as real estate and precious metals are tangible hard assets. In other words, you can see and touch them. With real estate, for example, you can drive by with your family, point out the window, and say, “My IRA owns that”. For some, that’s important psychologically. This is especially the case in times of financial instability, inflation, or political or global upheaval.

Cons

As with every investment, there are risks and the same applies to alternative investments. Here are some of the most common cons of alternative investments.

Illiquid: Alternative assets are less liquid than their traditional counterparts, meaning it will be more difficult to exit the investment if it moves south. For example, real estate is an illiquid investment because of the difficulty to sell property quickly. Whereas stocks or mutual funds can be sold very quickly, with many investors willing to make the purchase.

Volatile: Some alternative investments are hard to predict, due to their unstable prices. For example, cryptocurrencies such as Bitcoin are considered "volatile" investments. While there is high reward, there is also high risk when making crypto investments. Real estate is another "volatile" investment, as witnessed during the 2008 financial crisis.

But not all alternative investments are considered volatile. Gold is often considered a safe investment, particularly during times of political and economic turmoil. There can be volatility in any investment you purchase, and these days, alternative investments are seen as a buffer against stock market volatility.

Complex: It is often said that alternative investments are more complex. This is true of some assets, but not all. For example, many investors turn to real estate because it is an investment they understand and trust more than stocks and bonds. Whereas hedge funds are more complex because investors employ high-risk methods to generate large gains.

Buying Alternative Investments with IRA Funds

Many people are unaware that they can purchase alternative investments with their retirement funds. Walk into a financial institution, such as Fidelity, and ask to set up a Self-Directed IRA. It’s unlikely that the institution will allow you to open a Self-Directed retirement account because they don’t make money this way. In other words, when you withdraw your funds and invest in a third-party for alternative assets, they gain no financial benefit from this transaction. Financial institutions make their money by selling the products and services that only they provide. However, you will have great success opening your SDIRA at a company that specializes in Self-Directed retirement plans, like IRA Financial. These companies serve as the Custodian of the Self-Directed IRA investments, and its specialists can often ensure that you don’t violate IRS (Internal Revenue Service) regulations. Furthermore, companies like IRA Financial can help you decide what type of retirement account works best for your individual situation. For example, if your self-employed, own a small business, and have no full-time employees, a Solo 401k may work best for you. However, if you want checkbook control, which is the ability to write checks without custodian consent, a Self-Directed IRA LLC may work best for you. Regardless of your situation, IRA Financial has a team of dedicated professionals willing to help you identify what type of retirement account works best for you.

Read More: Solo 401(k) Eligibility

Alternative Assets and Tax Benefits

In addition to the four main reasons investors are looking to use a SDIRA to make alternative asset investments, the tax benefits may be the most attractive.

Tax deferral literally means that you are putting off paying tax. The most common types of tax-deferred investments include those in IRAs or Qualified Retirement Plans, like a 401(k). Tax-deferral means that all income, gains, and earnings, will accumulate tax free until the investor or IRA owner withdraws the funds. As long as the funds remain in the retirement account, they will grow tax-free. This allows your retirement funds to grow at a much faster pace than if the funds were held personal. As a result, this allows you to build for your retirement more quickly.

Additionally, when you withdraw your IRA funds in the form of a distribution after you retire, you’ll likely be in a lower tax bracket and be able to keep more of what you accumulated. So, with using a Traditional IRA as a retirement savings vehicle, not only are you not paying taxes on the money you invested, you could be paying them at a lower rate when you finally “take home” your money. In other words, as long as the funds remain in the account, they grow without taxes eroding their value. This enables assets to accumulate at a faster pace. This gives you an edge when saving for the long term.

Roth IRA

A Roth IRA will allow a retirement account holder to generate tax-free growth in their Self-Directed Roth IRA. All income from the Self-Directed Roth IRA or Roth 401(k) plan will be exempt from tax. However, the Roth account must be open for five years and the Roth account holder must be over the age of 59 1/2. Under these rules, you pay no tax on the distribution amount. That means you can invest in alternative assets, such as real estate and cryptocurrencies, and never pay tax on any of the gains.

Learn More: Types of Self-Directed IRAs

Whether you have a Traditional or Roth IRA, or a Self-Directed plan, you know that you should contribute to your retirement, make regular payments, and have a solid goal in mind. Do you have a goal to retire around the world, but don’t know where to begin? Time to think about what you want to do (and how to do it) when you don’t have to do anything.

Retire Around the World

Traveling around the world is a legitimate goal for many people, especially once retirement kicks in and the daily grind no longer beckons. But living a nomadic life, or one where you’re away more than you’re home comes with unique challenges.

So how do you plan for it?

1. Know Your Retirement Goal

Do you want to travel around the whole world, or just part of it? Seeing everywhere in the United States is the goal of a lifetime, so decide if you want to see highlights at home or abroad. Painted desert, big city buildings, fog rolling in on the bay? All of these are possible if you plan early enough and put away enough money.

Or do you want to travel and see castles in Europe? Ireland, Romania, Germany? Or travel on your taste buds to treat your taste buds to every continent?

Get a sense of what you’re looking to experience, so you can plan to have your money last as long as your sense of adventure.

Is there a particular country you want to live in during retirement? Here’s a little tip: use your retirement funds to invest in a property in your dream country, and generate a steady income by renting it out. By the time you reach retirement age, you can finally live in that property! Just make sure you know of the potential tax consequences, particularly UBIT tax.

2. Know Your Interests

Are you looking forward to buying an RV and driving up and down the coasts? Or are you looking forward to traveling by 4×4 on a wildlife photography safari?

Planning your travel is more than just picking cities on a map, and planning your retirement adventures has to be more than just wishful thinking. As you’re planning travel for the rest of your life, or a significant portion of it, it pays to pay attention to your tastes so you can really map out where you want to go and what you want to do.

3. Know Your Preferences

Do you like to stay in a bed & breakfast when you travel? Is your idea of travel incomplete without a five-star hotel experience? If you’re taking in castles, will you want to stay in them? If you’re seeing small villages, will they be day trips from your hotel, or will you be experiencing life as a local?

Again, if you know what your preferences are, you can plan out your retirement journey to coincide with your tastes. You can also decide where you’ll want to save money or splurge.

4. Know your Options

It’s important to know what you need to do to get where you want to be. If you hate flying, but really want to travel the world, it might behoove you to get over your fears. If you want to see the world but only want to travel by cruise ship, you’ll need to know what your itinerary can look like.

5. Know your Expenses

If you have big dreams, talk to a financial advisor or do your own research, and put money towards your dream. No one wants to get to retirement and have a five-star dream but a living-in-your-car reality. If you plan on retiring around the world, it makes sense to start planning early. A life on the go is very different from a week-long trip, and brings its own challenges. You’ll have to look into health care, lodging, communication options for anyone left back home. It’s a lot to think about, and a lot to consider. But saving regularly can help you reach your goal.

Let your IRA work for you through the power of tax-deferral and through the lucrative investments you make over the years. Investing with your retirement funds may seem intimidating, but when you establish an IRA that is self-directed, you can make investments you actually understand, not just the investments within Wall Street. For example, if you’re a savvy real estate investor, why not use your retirement funds to invest in an Air BnB property?

Retirement is the start of a new chapter – so make it the best. Take advantage of these moments to plan for your future. Even if you’re a Millennial and retirement seems like a lifetime away, planning now will make those Golden Years the best of your life.

Conclusion

Alternative investments offer multiple benefits. Before deciding to invest in alternative investments, it is imperative that you identify a Self-Directed IRA or Solo 401(k) custodian. Furthermore, it is important that you ask what types of alternative investments they offer. At IRA Financial, we offer a broad range of alternative investments. However, some Self-Directed IRA companies only allow individuals to invest in Cryptocurrencies or precious metals. Hence, it is important to identify what types of alternative investments you can make before opening a Self-Directed IRA or Solo 401(k).

It is also important to ask your potential Self-Directed IRA or Solo 401(k) custodian about their fees. Many alternative investment companies claim to offer free accounts. Despite this claim, many companies charge account valuation and transaction fees. At IRA Financial, you can invest in countless alternative investments for an annual fee. Avoid transaction fees, valuation fees, and invest in what you know and love. To set up an account, you can download our app, use the get started button, email us at info@irafinancial.com, hit the chat button or calls us at 1-800-472-0646 for any questions you may have.

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by Adam Bergman