Pros and Cons of Adding Alternative Investments to Diversify Your IRA
The potential for higher returns from alternative investments such as real estate and private equity comes with some risks. Are they right for you?
When planning for retirement, one of the key factors that can significantly impact your financial security is the composition of your investment portfolio. Traditionally, individual retirement accounts (IRAs) have been associated with standard investment options like stocks, bonds and mutual funds.
However, savvy investors are now exploring the advantages of diversifying their IRA holdings by adding alternative investments. What are the pros and cons of incorporating alternatives into your IRA, and why should you incorporate alternative investments into your IRA to optimize your financial future?
Here are four reasons why you should include alternatives in an IRA:
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Enhanced portfolio diversification. Adding alternative investments to your IRA can reduce risk and enhance portfolio diversification. Traditional investments often move in tandem with the broader market, making them vulnerable to market fluctuations. Alternative investments, such as real estate, private equity and hedge funds, have a low correlation to traditional assets. Thus, they can act as a hedge against market volatility, safeguarding your retirement savings.
Potential for higher returns. Alternative investments have the potential to generate higher returns than conventional assets. Private equity and venture capital, for instance, can offer significant returns over the long term, outperforming stock market averages. By including alternative investments in your IRA, you create opportunities for exponential growth and wealth accumulation.
Hedge against inflation. Certain alternative investments, like precious metals and real estate, have historically proven to be effective hedges against inflation. Inflation erodes the purchasing power of traditional assets, but tangible alternatives tend to retain or increase their value during inflationary periods, safeguarding your retirement funds. As we see volatility within the market, and questions persist if inflation has been killed, this can help ensure you have a hedge for future shocks.
Access to unique opportunities. By diversifying your IRA with alternative investments, you gain access to unique and exclusive investment opportunities not available through standard investment channels. Private equity, hedge funds and venture capital opportunities can be reserved for accredited investors, providing you with a chance to participate in high-potential ventures.
What to consider when investing in alternatives
There are risks to including alternatives in your IRA. All investors should ensure they are well positioned for the potential issues that could present themselves as they begin to invest in alternatives.
This is what any investor should consider:
Lack of liquidity. One major drawback of alternative investments is their relatively low liquidity. Unlike publicly traded stocks and bonds, it may be challenging to sell alternative assets quickly. Certain alternative investments, such as private equity and real estate, often require a more extended holding period, potentially limiting your access to cash in emergency situations.
Higher fees and expenses. Alternative investments typically come with higher fees and expenses compared to conventional assets. Costs associated with managing real estate properties, hedge funds or private equity funds can eat into your overall returns, impacting the growth of your retirement savings.
Limited regulation and transparency. Unlike publicly traded securities, alternative investments are subject to fewer regulations and reporting requirements. This lack of transparency may expose you to higher levels of risk, as you may not have complete visibility into the underlying assets or the investment strategy.
Complex due diligence. Investing in alternative assets requires a higher level of due diligence. Understanding the intricacies of specific markets, businesses or projects is essential to make informed investment decisions. Without thorough research, you might expose your IRA to potential losses.
Are alternative investments right for me?
Incorporating alternative investments into your IRA can be an effective strategy to diversify your portfolio, potentially leading to higher returns and a better chance of achieving your retirement goals. However, it is crucial to weigh the pros and cons carefully, considering factors such as liquidity, fees and complexity.
If you are in the position to invest in these kinds of investments, they can lead to greater returns, and be effective hedges against volatility within the market. Striking this balance can empower you to build a robust and secure retirement future for the long term.
How can I add alternative investments to my IRA?
Although most major brokerages like Schwab, Fidelity or Vanguard don’t support investing in alternative investments, a new wave of innovative companies are making it possible for the first time. We recommend looking at:
- Directed IRA allows you to invest in almost any alternative investment and has a great support team.
- Alto IRA provides a limited number of options, but is good for crypto.
- Millennium Trust allows you to invest in almost any alternative investment.
Combining these platforms with the emerging alternative investment platforms that have options for individual investors can be an excellent combination. We recommend looking at:
- Equi, great for elite hedge funds and diversified uncorrelated liquid alternatives, limited to accredited investors. (I am the CEO of Equi.)
- Percent, a strong solution for private credit, also limited to accredited investors.
- Fundrise, one of the top providers of real estate investing options for individuals, both accredited and non-accredited.
- AngelList, one of the best places to invest in early-stage venture capital, limited to accredited investors.
Please see important disclosures for Equi (Equilibrium Ventures, LLC) at www.equi.com/blog.
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