We all want to get the most out of our retirement planning, and hope to direct our savings and investments into profitable ventures that set us up for a comfortable retirement. We can learn a few tips from the wealthiest investors we call "the top 1%" when deciding how to invest our self-directed IRAs.
You may think that the kind of wealth we’re talking about is unattainable. However, Money Magazine breaks it down fairly simply in this article, where they cited a report by U.S. Trust, based on a survey taken of some pretty wealthy investors with a minimum of $3M in holdings. The report is called Insights on Wealth and Worth, and they found that “58% of the wealthy individuals surveyed said they came from a middle-class background, and 19% grew up poor. And when asked how their wealth was accumulated, respondents estimated that they acquired just 10% on average through inheritance, while 52% came from earned income and 32% from investments. (The remaining 6% was from unspecified other sources. Vegas? The lottery? )”
This indicates that with a will and a way, we can all build wealth using proper savings and investment strategies (which probably shouldn’t include Vegas or the lotto, just so you know!). Investing early and enjoying the benefits of compounding interest on those investments is a tried-and-true method of retirement planning, and, according to the aforementioned survey, is also how most of the respondents earned their own high net worth. Interestingly enough, well over half of the 650+ surveyed responded they did incredibly well with the traditional stock and bond investments. Only 11% listed investing in alternative assets, “including hedge funds, private equity, timberland, and art.” For those of you interested in self-directing your retirement plans—any of those alternatives (except art) are permissible in these plans.
It’s worth noting that this article seems to strongly support sticking to the most traditional, long-term assets, like stocks and bonds, and even suggests that diversity in more sophisticated and expensive investments can “de-worse-ify” (their words, not ours!) your portfolio. The author didn’t appear to be against alternative assets in particular—and we agree that you definitely should not sock all your money into a single investment or two. Also, you absolutely don’t have to go the sophisticated route if you’re not qualified for that, either. However, alternative assets—like real estate (timberland?), hedge fund options, precious metals, private lending opportunities, and so much more are available in self-directed IRAs and can also present the potential to build wealth over time in your portfolio. As these accounts become more widely known and used, the retirement planning industry is seeing an upswing in self-directed plan usage.
According to recent reports, $146 billion of the $7.3 trillion (roughly 2%) of American retirement funds are in self-directed IRAs. The Investment Company Institute reports a 21% increase in self-directed plan usage over the past three years. That number is expected to continue rising, which means that more people are choosing to take control of their own retirement funds and investing decisions—and gain access to an incredibly large pool of alternative assets. And, that’s a perfect lead-in to two of the favored investments that the elite top 1% choose to use to build income, which (drumroll!) are also permissible in self-directed IRAs!
What are some of the investing strategies the wealthiest choose?
One way the top 1% build wealth is by investing in businesses. In fact, according to this article on ZeroHedge—business equity is one of the primary assets owned by the revered one percenters. Additionally, the article states, “It's also worth noting that the wealthiest 10% own over 90% of the securities and stocks, 84% of trusts (essentially tax havens) and almost 80% of non-home real estate (i.e. second homes and income-generating properties).”
Now, while you cannot invest in a second home for yourself with IRA funds, you are able to invest in other income-generating properties, along with securities, stocks, LLCs, trusts—and much more with your retirement funds—to hopefully earn income the in same way that the top one-percenters do! Let’s explore two popular investments favored by the wealthiest investors—business equity and income-producing property, which also happen to be popular assets in self-directed IRAs.
Investing in Business Equity
Self-directed plans may own businesses or shares in businesses, start-ups, corporations, etc., to build tax-sheltered income for retirement. This means that your IRA can become part or full-owner of a thriving business by investing funds into the business you choose. You will not have to come out of pocket to manage and grow this business investment. Actually, you can’t use personal funds to facilitate anything your IRA owns. All income and expenses derived by that investment flow directly into and out of the IRA/retirement plan. But, you can use the tax-sheltered wealth earned from the investments in your retirement plan to manage and grow that account by reinvesting those gains.
Investing in Income-Producing Property
Investing in real estate that can be improved and resold for a higher value is one way to use income-producing property in your self-directed IRA. And, if the top 1% can do it, so can you! You may not have the big bank they do, but there are smaller rehab-and-flip projects that may be within your reach. Additionally, commercial and residential rentals (single or multi-family dwellings), and even foreign vacation homes fit the bill here. The key is to invest smartly, thoroughly do your research, and understand the expenses involved above and beyond the purchase of your initial investment.
No matter how you choose to use your retirement funds to invest, know that while there is always risk—a successful endeavor has the potential help you build substantial retirement income. Again, when your IRA owns the asset, all expenses are paid by the account and all income flows directly into your plan on a tax-sheltered basis. If your investments are fruitful, you’ll gain more and more capital over time inside your retirement plan to continue reinvesting, which provides the chance for you to continue building wealth in your account—in the same way it works for the wealthiest investors!
If you have questions about this article or wish to learn more about self-directed investing, please contact Scott Maurer, director of business development at Advanta IRA by clicking the link below or calling (800) 425-0653.