(Money Magazine) -- Question: I don't want to invest in the traditional choices of stocks, bonds and mutual funds in my IRA. Is there an account I can transfer my existing IRA to so I have more control over what I invest in? -- Bob, Morrisville, Vermont
Answer: Yes, there is a type of account that allows you to expand your investment options. It's called a self-directed IRA. And if you Google that term, you'll instantly come up with a slew of links to custodians that will gladly let you choose from a veritable smorgasbord of investments for your IRA.
Indeed, one such firm lists 17 different "permitted investments" on its site, ranging from the usual non-traditional suspects (real estate, land, mortgages and deeds of trust) to the more unusual (private limited partnerships, structured settlements, foreign currencies, accounts receivable).
But I think this is an example of one of those many situations in life where just because you can do something doesn't mean you should. In fact, I would discourage most people from turning their IRA into receptacle for a hodge-podge of alternative or quirky investments.
Why?
Well, in my experience the interest in these sorts of accounts tends to mount after the market has crashed or is in the doldrums and investors are casting about desperately for some investment, any investment, to rescue them -- or at any rate, any investment aside from the standard triumvirate of stocks, bonds and funds.
The last time I remember a big push for self-directed IRAs was back in the early to mid-2000s. The roughly 50% drop in stock prices from their early decade highs still had investors feeling skittish about equities, while at the same time the housing market was going gangbusters.
At first I noticed a dribble and then a steady flow of pitches into my email box from IRA custodians touting the virtues of opening a self-directed IRA and filling it with...what else? Real estate! And not REITs or real estate mutual funds. I'm talking single-family homes, condos and apartment buildings.
At first blush this invitation to stuff your IRA with various forms of bricks and mortar seemed to make perfect sense. The stock market was down, house prices had climbed 50% over the previous five years and everyone expected real estate values to continue to soar to the sky.
I remember writing a column back then that discussed self-directed IRAs and cautioned not just about the wisdom of tying one's retirement fortunes to a real estate market that appeared overheated, but also warned about some of the practical difficulties of stashing actual homes or apartment buildings into an IRA.
For example, if the rental home in your IRA needs a new roof, paying the $20,000 from your own pocket to make the repair would put you afoul of the annual maximum IRA contribution limits and possibly subject you to onerous penalties.
I also noted that it's very hard to diversify with actual real estate. Most likely, you'll end up owning one or two properties in one town. If the economic prospects for that particular area sour, you could find yourself in deep do-do.
Unfortunately, given the house-buying frenzy at that time, the reaction I got from many readers was this: So how, exactly, do I set up a self-directed IRA and put real estate in it?
But before you go sticking your retirement savings into equipment leases, parking spaces, fishing quotas or any of the other non-traditional choices that are often hyped as potential IRA investments, I suggest you take a step back and think about your real motivation.
At the risk of sounding like Paul Weston, the psychologist in HBO's In Treatment, is it possible that rather than a coolly rational move to take advantage of opportunities in new asset categories that you're giving in to emotion and simply fleeing investments that haven't performed as well as you'd hoped recently? Or that you're just joining the rush into assets that have surged lately, like gold?
I think you also need to ask yourself how much you know about many of these alternative investments. Granted, stocks and bonds have risks. But so do all investments. By moving into asset categories that aren't as well traveled as conventional investments, you may be trading the risks you know for ones you're not familiar with and that could surprise you in unexpected ways.
You also talk about wanting to have more control over what you invest in. But let's be clear. A self-directed IRA may give you more control over the types of investments you can own. But it won't give you more control over returns. Many people don't appreciate this distinction.
They feel that by investing, say, in distressed real estate and doing savvy rehabbing and smart marketing they can effectively create their own rate of return. But that's an illusion. You may be able to enhance your return through smart selection and keeping costs down. But ultimately market forces determine the level of return you'll get.
If you decide to go ahead with this venture, then at the very least proceed slowly and think of these alternative investments not as the core of your retirement portfolio, but as possible diversifiers for a small portion of your savings. Given the high fees, poor liquidity and complexity of many non-traditional investments, I think it's dangerous to have much of your retirement security riding on them.
Finally, be aware that there are prohibitions on the types of investments you can actually buy for an IRA (for example, collectibles, including rugs, antiques, gems and artworks are taboo) as well as the kinds of transactions you can engage in (selling property you own to your IRA or buying property with IRA funds for personal use, to name two). For details as well as the consequences for violations, see IRS Publication 590.
None of this is to say that a self-directed IRA can't work for some people in some circumstances. But I think for such an account to be successful, it requires not just self-direction, but an inordinate amount of self control as well.
Overnight Avg Rate | Latest | Change | Last Week |
---|---|---|---|
30 yr fixed | 3.80% | 3.88% | |
15 yr fixed | 3.20% | 3.23% | |
5/1 ARM | 3.84% | 3.88% | |
30 yr refi | 3.82% | 3.93% | |
15 yr refi | 3.20% | 3.23% |
Today's featured rates:
Index | Last | Change | % Change |
---|---|---|---|
Dow | 32,627.97 | -234.33 | -0.71% |
Nasdaq | 13,215.24 | 99.07 | 0.76% |
S&P 500 | 3,913.10 | -2.36 | -0.06% |
Treasuries | 1.73 | 0.00 | 0.12% |
Company | Price | Change | % Change |
---|---|---|---|
Ford Motor Co | 8.29 | 0.05 | 0.61% |
Advanced Micro Devic... | 54.59 | 0.70 | 1.30% |
Cisco Systems Inc | 47.49 | -2.44 | -4.89% |
General Electric Co | 13.00 | -0.16 | -1.22% |
Kraft Heinz Co | 27.84 | -2.20 | -7.32% |
Bankrupt toy retailer tells bankruptcy court it is looking at possibly reviving the Toys 'R' Us and Babies 'R' Us brands. More |
Land O'Lakes CEO Beth Ford charts her career path, from her first job to becoming the first openly gay CEO at a Fortune 500 company in an interview with CNN's Boss Files. More |
Honda and General Motors are creating a new generation of fully autonomous vehicles. More |
In 1998, Ntsiki Biyela won a scholarship to study wine making. Now she's about to launch her own brand. More |
Whether you hedge inflation or look for a return that outpaces inflation, here's how to prepare. More |