The term, self-directed IRA, appropriately identifies exactly what this kind of retirement account does and how it works. There are two primary factors that differentiate a self-directed IRA from a traditional or Roth IRA: investment direction and investment opportunity.
A self-directed IRA is a retirement account where the investment direction is managed by the plan’s owner. This is one of the two primary differences between a traditional or Roth IRA and a self-directed IRA. A traditional or Roth IRA is managed by a custodian at a household name, mainstream brokerage firm. However, self-directed IRAs are less common than the traditional or Roth IRAs, so it’s not unusual for many financial advisors to be unfamiliar or not well versed in self-directed IRAs as a retirement strategy. It’s important to note that a self-directed IRA does still require a custodian or trustee, the difference is that the investment decisions are solely made by the plan’s owner as opposed to the custodian. Investment assets such as rental property must have a title written in the custodian’s name in order to ensure the custodian can value the asset on an annual basis.
The second primary difference between the two retirement account strategies is in the types of assets they can hold. A traditional or Roth IRA is restricted to stocks, bonds, CDs, and mutual funds that are typically managed by the institution that governs the fund. However, a self-directed IRA allows the investor much more freedom in the diversification of their portfolio. Self-directed IRAs can invest in real estate, private market securities, limited partnership, precious metals, private partnership, crowdfunding investments, and so on.
Self-directed IRAs come with a vast array of options, customizations, unique opportunities, and to many, financial control and freedom. In fact, the reason self-directed IRAs are so popular with many experienced investors is because of the higher returns that can come from greater asset diversification. In addition, asset diversification is a precautionary strategy in that an investor can rely on a specific set of assets for growth if the stock market shifts unfavorably for another set of assets.
While there is a greater freedom in investment options with a self-directed IRA, they are still held to the same IRS regulations, including prevention of the personal use of assets held in the portfolio, as traditional IRAs. With this freedom, comes the need for extensive due diligence and thorough research because not doing so can easily result in penalties and loss. However, as information becomes more widely available and the desire for sustainable long term financial freedom matches the opportunity to gain it at a competitive edge – this strategy has become more popular and more favorable for many investors.