Thursday, September 12, 2013

Self Directed IRA’S – What Can You Put In There?

Occasionally we have clients ask us about adding alternative investments to their IRA accounts. Most inquiries that we receive come from those looking to add actual gold or a piece of investment property to their IRA funds. Other requests include adding a privately held company or limited partnership to an account; or even art and other collectibles. In many cases you can use your IRA funds to buy and hold these investments; however you will likely need to open a separate account through a separate provider that offers these self-directed IRAs. Generally, neither Charles Schwab nor Fidelity will be able to handle these types of investments. The self-directed IRA would therefore be held apart from any IRA you may have consisting of stock, bond and mutual fund investments.

Art and collectibles, like stamps, are not eligible to be held in IRA accounts of any kind. Assets dedicated to personal use, including real estate, are also not eligible to be held in a self-directed IRA. An example of this would be purchasing a vacation home available for use by you or your family members and wanting to deposit that home into your self-directed IRA. This would not be allowed. However, rental property, gold bullion or an investment in a private company (with some restrictions) would all be permissible in a self-directed IRA. There are several providers who offer this service, although none are generally recognizable to the public.

First, we are not big proponents of self-directed IRA’s in part because the account custodian often charges a significant fee for merely keeping record of these investments. In addition, many of the investments that folks would like to include in their self-directed IRA are often very illiquid and hard to value. Monetizing these alternative assets can be difficult in an emergency, when it’s time to start accessing your IRA for retirement income or for required distributions after age 70 ½. Finally, we believe that often times there are flaws with the investment thesis behind these ideas.

As I mentioned before, gold seems to be a common request. “Can I buy gold bars and gold coins with my IRA money?” Sure you can hold certain gold coins in your self-directed IRA, but as an alternative you could invest in a gold ETF or companies that mine gold, creating less hassle and less expense. In addition we find that investors often want to own gold for dubious reasons, the most popular being to protect against inflation or a weak U.S. Dollar.

Some research suggests that the best correlation with gold is actually its negative correlation with real interest rates, not inflation. We’ve seen this play out in 2013 as interest rates began to normalize just as gold had begun to tumble. Needless to say, this correlation is not perfect as we can find instances where this relationship does not hold true, but it is still worth considering. The somewhat unpredictability of gold, as well as its lack of correlation with any other asset class, is often cited by those who believe that there is, in fact, a benefit to owning gold. Since there are no earnings, dividends or interest with which to assess gold or other precious metals, it is very difficult to value. It is impossible to justify whether the true price of gold should be $500 or $1,500, which is another reason we do not recommend gold as a permanent position.

Over any relatively short period of time you will likely be able to find one asset class or another that stands out as the leader during that brief stretch. Sometimes it’s going to be stocks, sometimes bonds, sometimes commodities and at other times real estate. Looking at asset returns over very long periods of time indicates that investing in enterprise (stocks) has historically produced superior returns compared to the other categories. Large Cap US Stocks have produced annualized returns of 10% over the past 85 years or so, while gold has produced annual returns of closer to 5%, which is below the nearly 6% annual returns that bonds have produced. Real Estate return data is harder to come by but by most accounts the returns are lower than stocks, but still higher than bonds and gold.

So is a self-directed IRA right for you? Most likely not, but as always, if you would like to schedule an appointment, we would be happy to provide a complimentary review of your financial and tax situation.

Edward J. Wilcox, CFA

No comments: