If you were adding diversity to your wardrobe, you certainly would not consider yourself covered for any occasion if all you owned were five pairs of cargo shorts, each in a different color. Or how about you ladies: If someone invited you on a nature walk, how would it work if you had stocked your closet with nothing but a wide variety of high-heeled shoes? A Self-Directed IRA allows you to diversify your retirement portfolio.
While these examples may sound absurd, many investors take a similar approach when they diversify their holdings. They purchase stocks in five different large-cap energy companies and believe they are adequately diversified. Unfortunately for them, true diversification requires a broader method for picking investments, and they may not realize their mistake until the next market correction.
Initially, you can see look at owning stocks and bonds for diversification in your portfolio. From there, you could add different sectors such as technology, finance, energy, and consumer goods. You could further divide them up between large and smaller companies.
Today, most investors get a mix of stocks and bonds through a mutual fund. There are thousands of these from which to choose, and they come in a wide variety of styles: stocks, bonds, international, and specialty funds. And each of these can be broken down further into several categories that include stocks in all sectors, sizes, and types—and bonds that are taxable, tax-free, high-yield, or inflation resistant.
With all these choices, you would conclude that true diversity can surely be accomplished through these many choices. But, stealing the words from Porgy and Bess, it is not necessarily so.
A better approach to diversification
Today you can purchase an index fund that contains all of the stocks that are currently being traded. That sounds like you have got yourself well protected against a downturn in the market, does not it? Yes, it does sound like it, but in reality, all of those stocks will work in tandem. In other words, they will all decline to some degree when the market does.
What you actually have is a diversified stock portfolio, when what you really want is a diversified investment portfolio. Your goal should be to own a variety of assets that do not move in tandem so that when some asset classes are on the decline, others are rising, giving you a chance to react while protecting your nest egg.
A Self-Directed IRA allows for true diversification
Adding asset classes to your portfolio will help to diminish risk, provide a hedge against inflation, and give you a better opportunity for higher returns. Here are some asset classes you should consider and the benefits they bring to your allocation:
- Real estate can provide a steady stream of income to your retirement investments while giving them the added potential for capital growth. It takes you away from the stock and bond markets and into an asset class that most investors can understand.
- Precious metals typically run counter to the stock market, which is what you want in asset allocation. Gold has long been acknowledged as one of the best hedges against inflation, and it has a lower risk than many investments.
- Private stocks usually provide higher returns (with more risk) than the more common equities, and they can add even more diversity to a retirement portfolio.
Even more ways to achieve diversification
In addition to the three alternative investments mentioned above, you can also consider the following:
- Limited Liability Company (LLC)
- Joint ventures
- Venture capital
- Office building
- Industrial building
- Single-family homes
- Mobile home park
- Multi-family buildings
- Mortgage notes
- Limited partnership (LP)
- Oil and gas investments
- Other precious metals such as silver, palladium, and platinum
- And the list goes on
Diversify with alternative Investments in a Self-Directed IRA
Diversifying your retirement portfolio does not have to be daunting. Take control of your investments with a Self-Directed IRA, and you can add any investment that the IRS allows.