ira dIRA Diversification With A Self-Directed IRA

Wikipedia defines diversification as:

A risk management technique that mixes a wide variety of investments within a portfolio. It is the spreading out of investments to reduce risks. Because the fluctuations of a single security have less impact on a diverse portfolio, diversification minimizes the risk from any one investment.

Most everyone is familiar with the concept of investment diversification or IRA diversification. Any financial planner worth his/her salt will recommend that you refrain from putting all your money into one investment or one type of investment. Spreading wealth helps reduce overall loss potential.

Many people diversify their retirement wealth into different growth funds, balanced funds, index funds, small cap, large cap etc. There is a problem however with this view of ira diversification…..yes it is diversified….but only within securities and security related investments. But what happens when the stock market crashes? Did anyone’s IRA stock portfolio feel strong in March of 2009? Did you experience some portfolio volatility on May 6th 2010 when the market dropped nearly 1,000 in less than ½ hour?

Would a car salesman sell you a bike?

There is a world of possible IRA investments outside of publicly traded securities. ‘Alternative’ assets like real estate, private equities and notes are allowable investments for retirement plans and are essential to a truly diversified portfolio. The problem that most people run into is their current IRA administrator won’t allow them to invest in alternative assets within their retirement plan. Quite frankly, why would they? A stock broker makes money by selling stocks. So if you call your stock broker and ask what you should invest your IRA into…. they will probably say stocks. If I go to a car dealership and tell them I want to buy something…. they will probably try to sell me a car. There are two reasons most banks and brokerage companies don’t allow alternative assets within retirement plans:

1. They can’t earn commission from selling ‘alternative’ assets like real estate, private placements and private notes.

If they can’t make money off these investments they won’t promote the fact that they are available. Unfortunately for us everyone knows what the big banks and brokerage companies do… not everyone knows how self-directed plans work. IRA diversification can really start with a Self-Directed IRA because choices begin to appear in front of your eyes.

2. They are not set up administratively to hold alternative assets.

A real estate closing is quite a bit more involved than a simple stock or mutual fund investment. To make it work you need to have your IRA with an administrator that is specifically set up to hold alternative assets.
Obviously, securities are the biggest piece of the investment pie for most portfolios. There are roughly $4 trillion in IRAs currently in the US and the vast majority of those funds are in securities (in particular mutual funds). Alternative assets like real estate will never dethrone securities as the primary IRA investment. However, if you want a truly diversified IRA, you can’t have everything in the securities market.

As a self-directed IRA administrator we cannot tell you what to invest your IRA or 401(k) into; however, we can provide for you the broadest spectrum of investment options. If you have IRA or other qualified funds, you can move a portion of those funds to an account with Entrust New Direction IRA and invest them in non-security related investments. Most of our clients don’t move their entire portfolio into alternative assets…. because then they are losing the securities component of diversification….rather, they move a portion of their funds so they have some money in the market and some in alternative investments.

These are strange times we live in, both financially and otherwise, and now more than ever you need to know what your investment portfolio looks like and make sure all your proverbial eggs aren’t all in one basket. If you have questions about what types of investments are permissible or how alternative assets can be incorporated into your IRA portfolio, please call our office or attend one of our upcoming events.

Photo courtesy of bransorem