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Why Are Self-Directed IRAs Becoming So Popular?

April 6, 2016

When NuView started 14 years ago, most IRA account owners were completely unaware that they could use their accounts to purchase assets outside the traditional stock market.  It was an industry served by administrators with a few thousand accounts, mostly used to purchase real estate.

Evidently much has changed.  At the 2016 industry conference I attended in Washington for self-directed IRA administrators and custodians, we learned the growth of IRA assets being self-directed during the past year was at its highest point ever.

What has suddenly made self-directed IRAs so popular?

More people are becoming aware

Although it didn’t happen in a day, there is little doubt that the internet is largely the reason for the surge of interest.  Compared to the marketing budgets of the major brokerage houses such as Fidelity and Charles Schwab, self-directed IRA companies generally rely on speaking engagements and the Internet to get the word out.  While the Internet provides a great voice for the industry, it comes with the drawback that anyone can publish information or disinformation.

Sellers of private investment offerings have also caught on and are introducing potential investors to the concept of using their IRAs.  Who hasn’t seen or heard advertisements on how you can buy gold and silver with your IRA?

Probably the most powerful megaphone for the alternative IRA investments is word of mouth from those who already hold self-directed accounts.  Now that there are close to a million of these clients, the word is spreading – we can see it based on the number of web searches on the subject of self-directed IRAs.

IRA account holders want to own a tangible asset

Many investors have simply grown tired of watching their stocks, bonds and mutual funds move up and down, fearful that their principal will be eroded and their retirement jeopardized.  They feel that owning tangible assets, such as real estate, precious metals or other titled assets in their IRA will reduce the chances that their investments will be worthless one day.

Others are concerned that although low interest rates are in place today, any significant inflationary cycles in the future could wipe out their investments, and they feel that real assets may provide a better refuge.

Investors want to be in control

Interestingly, every IRA application that we process at NuView contains a section that identifies the profession of the account holder.  It seems there is a certain type of individual who is intrigued with the thought of managing their own IRA funds.  Doctors, lawyers, airline pilots, entrepreneurs and engineers are highly represented as account holders.

These individuals have certain similar traits:

  • They enjoy learning – especially obtaining practical education that benefits themselves and their family.
  • They have a double dose of confidence in their own abilities – sometimes an unshakable belief
  • While they will listen to the advice of others, they want to make the final choice – they want to be in control

IRA owners want to hold long-term

Many traditional stock brokers are incented to move clients in and out of stocks in order to gain fees and commissions.  While clients in self-directed IRAs are not required to hold their investments for a lengthy time period, many choose to do so.  Some are in relatively illiquid investments, chosen because clients may not need a distribution for many years, and also because they may produce a better return than stocks/bonds/CDs.  Discounts of 20-30% on purchase prices or premiums on yield are often priced into these privately issued investments.

IRA owners want to hold short-term

One of the most difficult dilemmas for an investor is deciding when to sell an asset.  The tax structure of the IRS incentivizes investors to hold investments for at least one year in order to be taxed at the more attractive long-term capital gains rates rather than ordinary income tax rates.  Imagine a real estate investor who purchases a rental property and six months later has the opportunity to sell at a significant profit.  Without the benefit of holding the property in an IRA, he may be pressured not to sell it if his personal tax impact would be too high.

However, held in a self-directed IRA, that same asset could be sold without any tax implication, as this transaction would be tax-free inside an IRA.  This advantage frees investors to make the best buying and selling decisions without needing to consider tax implications or to involve a CPA.

The bargain hunters want to buy below retail price

The American consumer has been programmed to buy only when an item is on sale.  Outlet malls are now big business, and camping outside the Best Buy store on Black Friday Eve is a tradition.  Why not look for the same opportunities with an IRA investment?

The stock market’s intent is to bring buyers and sellers together in a transparent way in order to facilitate a fair price for transactions.  In essence, there is no such thing as an undervalued stock, as the prices are represented to the general public and all have access to purchase at that price.  A stock purchase is only a bargain in retrospect, if the market price later rises.

With a self-directed IRA, a client may be able to find assets to purchase without competing with millions of other buyers as in the stock market.  A private placement may be made available only to a small group of accredited investors.  A foreclosed home in your community may be obtained at 60% of its retail value.  A local business associate may want to borrow funds from your IRA at high interest rate because of his unique needs.

IRA investors believe that the best investments are private

We all like exclusive offers.  The implication is that we are being treated as special or getting something that others can’t have.

The truth is, a self-directed IRA does give you exclusive access to investments that a traditional brokerage house IRA cannot provide.  It is up to you to determine the best choices to make, but the array of options is amazing:

  • Real estate of almost any type, both commercial and residential
  • Notes and mortgages
  • Tax liens
  • Private placements
  • Precious metals
  • Joint ventures

Investors dislike management fees

Much has been made recently about making the management fees charged by mutual fund managers more transparent.  But according to Forbes Magazine, the expense ratio is only the beginning of the cost.  The true costs of these investments, even inside the tax-deferred wrapper of an IRA, can be over 3.1%.  (see Forbes “The True Cost of Owning A Mutual Fund,” 4/4/11)

With a self-directed IRA, an investor may still choose stock market investments, but most prefer to side-step offerings loaded with management fees and pocket the additional gains for their own retirement.

IRA holders may need greater cash flow than stocks/bonds and CDs provide

The current yield on a 5 year CD is a little less than 2%.  The average dividend yield of the Dow Jones Industrial companies is 2.87%.  Of the 414 stocks that pay a dividend in the S&P 500, the average dividend is 2.12%.

For many investors who seek cash flow, those yields are insufficient to meet their needs for retirement.  Their answer may be found in issuing notes backed by mortgages for individuals who need funds that banks are unwilling to lend.  We have seen clients lending at rates from 6% to 16%, secured by first mortgages on properties, all in their IRA.  Others purchase rental properties, either managed by themselves or by third parties, and continually reinvest the cash in additional properties, piling up assets for their retirement years.
Although there are many reasons why self-Directed IRAs are growing, my sense is that clients simply want to put their IRA to work in a way that they feel will provide a more stable and certain retirement.