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Posted over 3 years ago

Versatility of Self-Directed IRAs: Diversifying Your Portfolio in 2021

Throughout 2020, many investors have had to navigate murky waters. Early in the pandemic, it wasn’t clear how different types of investments and businesses would be impacted. But as time went on, we saw how different markets responded.

Now we see that COVID-19 cases and hospitalizations are surging again, and many states are implementing new restrictions. As we plan for the year ahead, it’s a good time to consider our investment portfolios and any steps we can take to further diversify. Now is the time to put the lessons we’ve learned to good use.

The word “diversification” is thrown around often, but it’s emphasized for good reason. Spreading your money out between 20 deals, as opposed to putting it all in one deal, may help limit your risk. The same is true for investing in different asset types. The five most common asset types (cash, stocks, bonds, real estate, and precious metals) were intended as a basic form of diversification and risk mitigation.

Even within those asset types, you could achieve further diversification to take advantage of market trends and hedge potential downsides. For instance, you might balance solid blue chip shares with tech venture or emerging market shares to capture growth. Or balance steady investments in consumer staples with more cyclical consumer durables, whose fortunes are more directly tied to the business cycle.

The Versatility of Self-Directed Accounts

If your retirement account is not self-directed, your options for diversification may be limited to traditional investments (i.e. stocks, bonds, and funds). With self-directed accounts, you can choose from a broad range of alternative investments, whether that be real estate, business ventures, private placements, precious metals, notes, and many more. Through an account administrator, you can direct every transaction.

Other than the few types of transactions prohibited by the IRS, the possibilities are endless! The ability to choose investment opportunities means that you can diversify across different asset classes, while enjoying the benefits of self-directed investing.

Not only do you have the freedom to choose what investments to make, but you also have more options on how to use them. For example, if you purchase and renovate a house with your IRA, the income you make from renting or selling that property flows back into your IRA either tax-deferred or tax-free (depending on the type of account you choose). With Self-Directed IRAs, contributions are made with post-tax dollars, but the money grows tax-free and isn’t taxed when you take it out. Essentially, you are being taxed on the seed instead of on the crop.

Plus, with you in the driver’s seat, self-directed accounts require less management (and therefore less management costs) than traditional investments.

Personally, I’ve utilized the full array of self-directed accounts, including IRAs, HSAs and ESAs to invest in residential properties, both single family and apartment complexes, mortgage notes, and commercial property. I mitigate risk by knowing the neighborhoods and area market conditions where the properties are located, as well as the service providers and contractors I use to maintain them. The mortgage notes are less hands-on and allow me to put my money to work without the time commitment required for managing properties.

Due to the pandemic, I will be further diversifying my portfolio by looking at suburban residential real estate in areas that are desirable to remote professionals,who are spending more time at home, need more room for workspace, and no longer wish to live full time in the city.

My family has invested in real estate for generations, so I began learning about it at an early age. Although getting into real estate investing myself was a natural transition, many people venture into alternative investments without knowing exactly what they’re getting into.

So, how do you know which alternative investments are right for you? Which asset types typically require more time and effort?

Active vs Passive Investing: Which One is Right for You?

Most types of investments exist on a spectrum of active to passive, and that depends on your role as the investor. As an active investor, you often have more control and say so over your investments. When you’re investing passively, you benefit from receiving “mailbox money,” or returns that come to you with less time and effort.

For example, in a syndication, you might raise capital or put a fund together to invest with other people’s money (OPM) and actively invest it. However, if you invested your capital into a fund and you’re not involved in the day-to-day decisions, you are passively investing. You’re making that return no matter where you are or what you’re doing.

Alternative Investments

Real Estate

Rental properties are passive to some extent. As a landlord, even if you don’t manage or repair the property yourself, you still need to hire a property manager and work with them. It is not a set-it-and-forget-it type of investment. If you invest in commercial properties with triple net leases, this is more passive since the tenant will take care of all the maintenance. Short term or Airbnb rental properties, on the other hand, usually require more involvement from the property owner. Some states are even requiring landlords to acquire business licenses to operate an Airbnb property.

Private Lending

Lending money long term is easier than doing so short term. If you’re lending money every year, you will need to continually find your next borrower. If you’re lending over a thirty-year term, it can be very passive. That said, those loans typically get paid off before the thirty years is up anyway. Non-performing notes, or defaulted loans, are much more active, as you may need to work with a servicer and attorney to work through the collections and legal process.

Precious Metals

Precious metals are another investment that is on the very passive end of the spectrum, and it is used in times of great uncertainty, such as wartime, significant economic downturns, or even geo-political unrest. It is a way to store wealth and protect it against FIAT currencies. That said, some people do actively trade metals based on the overall price of each type, including gold, silver, palladium, platinum, and more.

Tax Liens

When taxes are owed on a property, that debt can be bought and sold, much like the sale of promissory notes (i.e. note investing). If you purchase a tax lien as an investment opportunity, you would either collect payment from the property owner or you would pursue the property itself. Tax liens can be relatively passive or active, depending on state rules, regulations, and processes. Tax deed sales are more active than passive because you end up with the property as opposed to the tax lien note making interest.

Stock Dividends

Stocks and bonds can be both active and passive, depending on your style. Long term investing can be passive compared to day trading, where you are evaluating the market continuously. However, there are computer programs that help minimize your time and involvement.

Regardless of which investments you choose, be sure to educate yourself in them as much as possible. In addition to spreading my money between multiple deals and geographical locations, investing in what I know has helped me mitigate risk. Due to the internet and all the amazing resources that are readily available, investors have many avenues to learn about new opportunities.

Are there any investment opportunities that you want to learn more about this year? Better yet, what changes will you make to your portfolio in 2021?



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