Using a Self-Directed IRA is a popular way to invest retirement money in non-traditional assets like real estate and precious metals. But for some people, it also represents a clear opportunity they cannot get with a traditional strategy: putting money in private companies. “Private equity” simply refers to the same process of owning a piece of a company as you might do with a traditional brokerage account—however, here, the company you’re investing in is not publicly traded.
There are generally two ways to do this:
- Investing indirectly. Investors can use funds like a ‘private equity fund’ to put money into general funds like Venture Capital funds.
- Investing directly. This means buying a piece of a company with money in the Self-Directed IRA.
But there are a few questions. One, why would someone want to invest in private equity when there’s plenty of attractive public equity, and two: is this a valid strategy for someone seeking a self-directed retirement? Let’s look.
Why Invest in Private Equity with a Self-Directed IRA?
One of the great appeals of the Self-Directed IRA is that it helps you build a wider portfolio. Rather than focus all of your efforts on one source of returns—the public stock market—you will have an opportunity to diversify into different asset classes like real estate, tax liens, and, of course, private equity.
Private equity also has the advantage of astounding potential returns. Consider the example of an artist who worked for Facebook briefly—and elected to receive payment in the form of private stock rather than cash. When the company’s value took off, the astounding returns piled up to hundreds of millions of dollars. That’s the potential value of private equity.
That is not to say every private equity investment will be the goldmine that Facebook has been for some investors. But in identifying the key opportunities that may not be available to the public at large, a retirement investor can find tremendous returns—and held within an IRA, these returns will grow tax-deferred. Says US News: “According to the Private Equity Growth Capital Council, private equity outperformed the Standard & Poor’s 500 index by 5.2 percent during the 10-year period ending in 2015.”
What are the Strategies for Investing in Private Equity with a Self-Directed IRA?
Here are a few steps to consider when thinking about investing in private equity:
- Know your IRS limitations. As with any retirement investment, you will have to work within the framework of IRS regulations. Knowing these from the outset will not only help you avoid pitfalls but will prevent you from having unrealistic expectations as to how the process works.
- Understand what you are getting into. Investing in any individual stock is a high-risk, high-reward proposition. Taken as a group, the S&P Index tends to return something in the region of 10% per year in the long-term. But taken as individual stocks, you may see that there are winners and losers that vary wildly from stock to stock. Investing in private equity means you are often investing in only one stock, which will inherently have more volatility than would a broad stock market index fund.
With these tips in mind and understanding the risks and rewards associated with investing in private equity, you can incorporate a different asset class in your portfolio. Like any other asset class, bring your experience and wisdom to your individual investments and understand the benefits and limitations of using a retirement account.