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Uncovering the Hidden Option of Self-Directed Investing

It’s 2019, and today, it’s all about getting ahead of tomorrow. You’re either starting to prepare for your financial future, or it’s already on the horizon.

Of course, we’ve all been warned about the fast-approaching depletion of Social Security and are on notice about a looming recession. Stashing away money feels more urgent than ever. But even if we are diligently saving in a 401(k), IRA, and the like, watching our accounts zigzag up and down at a snail’s pace feels like we’re at the mercy of some unknowable force. It would be really nice to have some more options.

What about the ones that already exist? Well, with the state of financial literacy in the US right now, it’s not terribly surprising that many folks don’t know much — or anything — about self-directed investing. It’s just not something that’s advertised very often.

“Self-directed” is pretty much what it sounds like: You yourself choose what to invest in and direct an account administrator to make each and every transaction. When you look outside of traditional offerings, choice starts to mean a lot more, and you’re only limited by the few types of transactions the IRS prohibits.

Because you make all the decisions, self-directed accounts don’t require the kind of management (and therefore management costs) as the types of investments most of us actually are familiar with: stocks, bonds, groups of funds, etc. And when it comes to choosing what to do with your retirement accounts — no matter how late in the game it is — self-directed investing can be particularly advantageous over mainstream strategies.

If you’ve got any sort of tax-advantaged account, the financial institution that runs it probably gave you a bunch of “options” for how you could invest — different packages of stocks and bonds with varying levels of risk and prospectuses and annual reports — and that’s it.

A lot of people look at those options and think, Well, this is what I can pick from, so this is how it must work, and I have to pick the best of what’s here. But it’s actually just how that company’s plan works and what they allow. Because what about all the other ways people in life make money with their money — or have “money work for you”? Like buying real estate, renting, and selling it; investing in small businesses, buying gold, private lending, and so many other things?

The fact is, you can invest your retirement funds in all of those things. It’s where your mainstream brokerages fall short and where self-directing comes in.

It doesn’t make sense to those big banks and brokers to give customers the option of self-directed accounts with the level of flexibility allowed by law, so they simply don’t tell you about it. Self-directed IRAs have been around since IRAs were started in 1975. Even back then, institutions often would only let very wealthy clients have these kinds of accounts.

So now that you know self-directed accounts are another way to make your savings work for you, let’s look at how you go about doing it. Taking money out of any tax-advantaged account early isn’t ideal, because most of what you withdraw will be eaten up in taxes and penalties. Don’t worry, you’re not cashing out.

To work with the money you’re saving for retirement (and even if you’re already retired), you simply roll it over into a self-directed account and have an administrator or custodian conduct transactions on your behalf. All of the gains you make from your self-directed investments go right back into the account and are subject to the same tax rules as gains you’d have made letting a broker choose from traditional options.

Let’s say you purchase and renovate a house through your self-directed IRA. Any money you make from either renting or selling it goes right back into your IRA, and therefore would be either tax-deferred or tax-free, depending on the type of account it is. The great thing about real estate is that it’s a physical asset that can create fairly reliable returns such as rental income or appreciation, compared to, say, the stock market.

This is how some folks expedite the growth of their retirement savings, and it’s just one example. If you’ve ever thought about buying precious metals or investing in a startup, self-directed investing could be for you. It opens you up to many, many other ways to diversify and grow your nest egg and puts 100% of the control in your hands. •

These articles are not intended as investment or financial advice. Before making any investment decision, talk to your financial, tax, or legal advisers.

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