For 2018, Use Self-Directed IRAs to Help Diversify Your Portfolio
2018 was a great year for Self-Directed IRA investors and stock market investors alike. A strong economy and the prospect of corporate tax cuts (made a reality by the newly signed Tax Cuts and Jobs Act of 2017) sent both the stock market and alternative asset classes popular among Self-Directed IRA investors soaring.
That is very nice for those who invest by looking in the rear-view mirror. But most people smart enough to use Self-Directed IRAs and other retirement accounts to diversify their retirement assets know that the bigger the returns in the past, the tougher it may be to find acceptable returns in the future.
Veteran investors know: As asset prices increase, so does risk. And with the S&P 5oo gaining 19.42 percent for 2017 – on top of an 11.96 percent return for 2016 – the bull market in stocks has got to be getting a little creaky.
This does not mean we cannot continue to have good returns for a while: It depends on what happens to corporate earnings and whether they are strong enough to support the recent U.S. stock market returns.
Investors should use Self-Directed IRAs and other self-directed retirement accounts as a vehicle to help diversify their assets going into 2018. While there is no shortage of mutual funds and individual securities you can stuff into a conventional, old-fashioned broker-sold IRA, some assets are only available as retirement assets to those who use Self-Directed IRAs. For example:
Direct ownership of gold, silver and platinum bullion and coins.
Direct ownership of real estate.
Closely-held, private C-corporations. This asset class, especially, got a boost from the Tax Cuts and Jobs Act because corporate tax rates applicable to C corporations were significantly reduced, from 35 percent to 21 percent. Since dividends are not tax-deductible expenses for corporations, the previous tax regime punished owners of C corporations who relied on them for income, as the effects of double taxation were truly pernicious. Dividends from C corporations took a 35 percent haircut before they were even distributed to the owner, who must pay taxes on them either on their current income tax return (outside of retirement accounts) or when they withdraw the money from a traditional IRA, 401(k) or other retirement account.
The Tax Cut and Jobs Act does have the effect, though, of lessening the incentive of income-sensitive investors to direct money into REITs and Business Development Companies. This is because the tax benefit of treating these entities as flow-throughs is reduced by about a third, from a 35 percent tax to a 21 percent tax on their C corporation alternatives. It remains to be seen how this may affect capital flows to REITs and BDCs. We expect the impact to be relatively small, though, as the best reason to invest in REITs and BDCs is because of the investment properties of the real estate and microcap/VC-stage asset classes. Most people do not let the tax tail wag the investment dog, as it were.
At any rate, the case for diversification into real estate, precious metals, tax deeds and certificates, partnerships, LLCs, oil and gas investments and pipelines remains strong. A good economy should support a wide variety of asset classes, though it may force the Fed to continue to boost interest rates, which will tend to hurt existing bond portfolios.