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How a Self-Directed IRA Helps You Become an Investor

A self-directed Individual Retirement Account is like any other IRA, except it is directed by a trustee. Over the years, this trustee allows the owner to make a broad range of investments with this IRA, usually in stocks, bonds, and mutual funds. The law allows the owner of an IRA account to make wide range of investments with it, including loans.

That’s right, you can make a loan with your self-directed IRA.

The IRS regulates what kind of financial activity is allowed under one of these plans, but the various investments and loans allowed by regulators are broad. These plans let you invest in what you know and understand.

I’ll give an example.

Investing in a Startup

Investor Relations - Self Directed IRA Investments

Your IRA Could Help You Invest in a Family Member’s Startup.

Let’s say a brother or son or niece is trying to start a business. They’ve got the education and you have a deep belief they’ll do great things in this world, but their credit history is nowhere near what it should be to obtain financial backing in the form of a small business loan.

They have trouble with the financing and it’s going to set them back years before they can ever save the money to make their dream happen. This young family member comes to you asking for ideas about taking on investors. With the self-directed plan, you could become one of those investors.

In this scenario, you’ve been working in a cubicle for the last 5 or 10 years and you don’t want to toil away for another 5-10 years at the same job. You want to help, but you don’t know how.

With your self-directed 401k account, you can make that family member a loan to start that business. With the permission of the trustee, you become lender who stands to make big interest on the loan. Polonius said, “Neither a borrower nor lender be,” but Polonius didn’t know about self-directed 401K plans.

Examples of permitted purchases include:

  • Real Estate
  • Stocks
  • Mortgages
  • Private Equity
  • Tax Liens
  • Partnerships
  • Franchises
  • Precious Metals

Self-Directed 401k Plans

About 30% of the 401k plans in the United States offer the self-directed option. If you have this option, you’ll need to look at the advantages and disadvantages before making the decision. Below are some pros and cons you need to consider before filling out the paperwork.

These retirement plans are offered by employers. The employer matches the funds you put into the 401K with the money you invest. In these cases, it’s best to max out what you can add, knowing that the money you invest is doubled.

In some cases, businesses only offer self-directed retirement accounts. If this is the case and you don’t know what to do, invest in basic mutual funds. This has the advantage of having an expert run the mutual fund, so you’ll end up getting the expert help you need in an indirect way.

Another option for the person given no other choice but this option is to invest in an exchange-traded fund which is offered by one of the reputable firms like Schwab, Fidelity, or Vanguard.

Who Should Avoid the Self-Directed Option?

Several major problems exist with these plans, though, so I’m going to suggest certain people should avoid this type of plan. If you have no experience at investing, avoid this type of retirement plan. If you have trouble controlling your impulses, avoid this type of retirement plan. If you feel like you hit the panic button a little too often when under stress, avoid this option.

The reason I make this suggestion is the fact these give you the liberty to make a wide array of choices. That can be a bad thing, if you don’t make good choices. Also, people can make sound financial decisions and still have bad luck. A person can chase bad money with good money when this happens. Like a problem gambler, a person with character flaws using a self-directed IRA or 401K can get themselves in a lot of trouble.

It can be overwhelming to study thousands of stocks and dozens of mutual funds. If this doesn’t sound like activity you want to do, it’s better that you turn your financial future over to an expert. While no one is going to care more about your retirement plan than you, caring isn’t enough. At the end of the day, you need someone who can make rational decisions. If that person is you, then a self-directed IRA or 401K is a good idea. If not, then you should trust your personal finances to an analyst or broker.

On the other hand, if you’ve got some experience playing the stock market, you consider yourself a sound investor, and you don’t make unwise decisions when stress inevitably happens, this is a chance to give yourself more financial flexibility.

In a lot of ways, what I said above goes for all your financial decisions. Bad fortune happens. Life isn’t perfect and everyone faces adversity. But at the end of the day, people who make good budget decisions tend to end up prosperous, and people who make bad personal economic decisions tend to end up in debt or bankrupt.

Many of the people reading this website should not involve themselves in this type of financial situation. If you’re having trouble with debt or you can’t get a decent credit card, then you probably shouldn’t be directing your own retirement plan. On the other hand, I think some of the readers of this blog have realized I offer good advice for a full range of individuals. If you fit the traits of a wise investor, then you might consider this option.

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