If you’ve ever heard of a Self-Directed IRA, you know that these accounts can do a lot to help you prepare for retirement. Investors often like that a Self-Directed IRA helps them go after the assets they want to invest in—for example, an investor with experience in real estate can use a Self-Directed IRA can hold real estate assets within a Self-Directed IRA and enjoy the protections that come with it. However, there is one key reason that many investors turn to a Self-Directed IRA: diversification. But what does diversification really mean, and what does it have to do with keeping a Self-Directed IRA, in which you choose your own asset allocation? Here’s what you’ll want to know.
Self-Directed IRA Diversification: A Definition
First, let’s start by talking about what diversification means as a general investment concept. According to Fidelity Investments, “Diversification is the practice of spreading your investments around so that your exposure to any one type of asset is limited.” In other words, diversification means you’re not putting all of your investment eggs into one basket.
Let’s take an example of the opposite to help illustrate what this looks like. Let’s say you were to open a retirement account and add only one stock to that retirement account. Day after day, month after month, you keep putting money into that stock. If the stock’s value goes up, you might feel like a genius. But some stocks go down, even when the rest of the market is up. If the stock’s value goes down, your entire portfolio goes down because you didn’t do anything else but invest in that single stock. And in the case of a disaster, like a company going bankrupt, this strategy could really come back to bite you.
Diversification is the answer to this problem. Because retirement savings is all about keeping a hold on the wealth that you saved up over the years, diversification means spreading out the risk. Maybe you buy multiple stocks, or even a mutual fund consisting of all sorts of stocks. Or, maybe you broaden even further, adding different asset classes to your portfolio. That’s where the Self-Directed IRA comes in.
Diversification Across Asset Classes
When you use a Self-Directed IRA, you can not only invest in a wide range of assets, but a wide range of asset classes. Think about it this way: even if you buy every stock on the market, you’re only as diversified as the stock market itself. But what if the stock market is down this year, while real estate prices are up? If you only own stocks, you may not be as well-diversified as you think.
Self-Directed IRAs let you set up more diversification in your portfolio because they give you the ability to broaden to asset classes like real estate, precious metals, tax liens, and private notes. You can even buy private company stock to add diversification to your portfolio—and you can do it all within a retirement account that gives you certain tax protections.
That’s one reason why investors love Self-Directed IRAs—they can provide even more opportunities for investors to broaden their investment horizons and create a truly diversified portfolio. And when you have a diversified portfolio, you may not feel so concerned when the stock market is down—because you know you’ve taken steps to secure your own financial future.