Entrust Learning Center > 1. Self-Directed IRA Basics > Conventional vs. Nontraditional Investments

Conventional vs. Nontraditional Investments

When speaking to people who have discovered the universe of self-directed IRAs, I often encounter potential investors who havesome trepidation about moving their funds out of more conventional IRAs that are invested in stocks and bonds.

By: Scott Maurer

IRA Insights

By Scott Maurer, JD

Most of these individuals have seen their accounts at brokerage firms fall tremendously over the last year or so. They are intrigued by the thought of nontraditional assets, like real estate, in their portfolios, but they voice the same line, “I want to wait until the Dow gets back to (insert any number here, 9,000, 10,000,and so on) before I make the transition.”In essence, they want to recapture some of their losses before they begin investing in nontraditional assets. Presumably, after restoring their account balance to a certain level, they will feel more at ease about investing some of those funds in less conventional ways.

It doesn’t take a PhD in psychology to realize that investors often do not like to stray too far from a comfort level they have with their money. However, the question investors should be asking themselves is not “At what point have I recouped enough of my losses to invest in assets outside of my comfort level?” The question should be “What investment strategies are going to enable me to most quickly recover my losses?”

It is no secret that the real estate and the securities markets have seen drastic downward spirals. Yet, despite each market being down, the prospects for rebound and long-term growth aren’t necessarily the same. There are many reasons to consider real estate and real estate-related assets as alternative investments and part of the diversification of your portfolio.

Investing in a self-directed IRA offers multiple ways to grow your account quickly.A real estate investment offers the potential to grow your retirement account in two ways at the same time. If you purchase rental property (be it a home, condo, or mobile home), your account accumulates rental income throughout the time that you own it. When you sell the property, presumably your account will also realize appreciation on the sale of the asset. So not only are you growing your account through the accumulation of rental income, you are holding an appreciating asset that returns additional gains upon the sale of the property.

For example, due to the depressed real estate markets, a home that was selling for $120,000 just three years ago mightbe available in foreclosure for $60,000. An IRA can purchase that house for $60,000, make $5,000 worth of improvements, and then make the home available for rent. If the home rents for $800 per month, the IRA will receive gross income of $9,600 a year. Even after paying property taxes, insurance, and minor repairs throughout the year, your IRA could net a return of $6,500 or more. On an investment of $65,000, that means your IRA is returning a very decent 10% annually. Then, if you are able to sell the house for $120,000 in five to seven years, not only did the IRA earn 10% each of those years but it doubled the initial investment upon the sale of the home.

A self-directed IRA can invest in tangible assets.  One prevailing theme I have heard lately from clients who are moving into the real estate realm is the fact that real estate is a tangible asset. Unlike stock in a publicly traded company, real estate doesn’t simply vanish due to mismanagement. In a constantly expanding world, real estate will always be a special commodity because it is a finite resource. Alternatively, with some securities, if a company goes bankrupt or out of business, you can be left holding worthless paper.

Being a mortgage lender offers some of the similar benefits of real estate.  Rather than purchase real estate, your IRA can loan money to buyers. If the loan is properly collateralized, even if the borrower ceases to payback the note, the IRA can foreclose on the property and own that tangible asset. The IRA then could treat the property as a rental unit and realize the benefits of owning income-producing real estate.

Many of our clients finance short-term, interest-only mortgages from their IRAs. In many cases, the IRAs charge 8% to 10% interest to the borrowers. Considering that bank CDs and money market accounts are currently paying at most 2% to 3%, investing in mortgages could certainly reap better returns for IRA owners.

It is always a good idea to diversify your portfolio, especially across different types of assets. Even if someone is not completely comfortable moving all retirement funds out of the conventional securities markets, diversification within a portfolio should not be limited to merely different types of securities. Holding different types of assets within a retirement plan helps guard against the kind of losses that many have experienced over the last several months. Diversification canalso help the investor tap into new ways to grow a retirement account.

Not all real estate or real estate-related investments (such as mortgages, private placements, and options) will perform as well or better than some investments in the securities arena. The important thing for investors looking to recover some of the losses suffered recently is to determine whichinvestment strategies enable them to most quickly recover their losses while offering long-term stability and growth. When addressing short-term and long-term growth, a prudent investor should assess all their options, and these options should include real estate and other real estate-related assets.

Scott Maurer is an attorney and the director of education andmarketing for Entrust of Tampa Bay, LLC. He can be reached at SMaurer@TheEntrustGroup.com or 800-425-0653 ext 1123.

 

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