Diversification isn’t just about spreading risk, it’s about taking control of your financial future with assets you actually understand.

Retoro Capital Investments

Diversification Outside the Stock Market

Getting an Individual Retirement Account (IRA) at work set up through HR is pretty easy to get started investing in stocks and mutual funds, but setting up a self-directed IRA (SDIRA) to invest in private markets takes some outside effort. This means you’re probably sitting on a retirement account stuffed with stocks and bonds that you try not to look at too often. But then at your last family picnic, your cousin's brother-in-law told you all about how he's making tons of money flipping houses, and now you want to get into real estate too. But you don't know how to use a hammer, and that one rental house you already have because you used to live in it and kept it when you upgraded to a nicer house is kind of a pain to manage, so you don't really want more of those. You're wondering if there's an easier, more passive way to diversify into real estate.

Spoiler: there is.

An SDIRA lets you passively invest in real estate, lending, and a wide variety of other private assets that churn out passive income, setting you up for retirement and a life focused on family and freedom. Here’s how an SDIRA could be your ticket to a richer future.

We are not financial planners; we are private fund managers. So while we can't give you investing advice, we can share what strategies we're using. Always consult a professional well-versed in and aligned with your goals and investing strategy: IRAs are not a DIY thing!

How SDIRAs Can Boost Financial Freedom When Used Well

Adding Private Real Estate to Your Retirement Portfolio

Complementing Public Market Investments

Most retirement accounts look like yours, loaded with stocks and bonds index and mutual funds, which are publicly paper assets. Mixing in some private assets, especially with some real assets mixed in, is a good recipe for diversification. Since most IRA custodians only manage public assets, getting your retirement accounts truly diversified means putting a portion into self-directed private investments.

We own several rentals outside of our retirement accounts, both single-family residential and commercial properties, so we can both actively manage them and use the depreciation to offset our income. Inside our SDIRA is where we hold assets that are totally passive and don't have depreciation. Then we have our public assets with a traditional IRA custodian. Both types of custodians can manage the full array of investing accounts such as Traditional IRA, Roth IRA, Solo 401(k), SEP, Coverdell, HSA, etc, so you can mix and match to create a truly custom retirement portfolio across public and private assets.

Unlike standard IRAs managed by active custodians who limit investments to public assets, SDIRAs are overseen by passive custodians who allow account holders to make their own investment decisions. This flexibility enables the creation of diverse, income-generating portfolios that support financial independence and retirement goals that have access to a full spectrum of private investments.

Keep publicly traded investments with your traditional IRA custodian, and open a self-directed IRA account for privately held investments not found on stock exchanges.

Benefits of SDIRAs for Financial Freedom

Diversifying with Private Real Estate

Most retirement accounts are heavily weighted toward public market investments like stocks and bonds. Adding private assets, particularly real estate, enhances portfolio diversification by reducing reliance on volatile markets. For example, my family holds directly-owned real estate in the form of several rental houses and commercial properties, both as active managers and passive investors, alongside groups of other investors inside and outside our fund at Retoro Capital Investments. We hold these for above-average returns, yes, but mostly for the depreciation benefits to our income and capital gains taxes.

As real estate professionals, we can offset not only our passive income with depreciation but also our active income. Therefore, for properties with depreciation, we choose to hold them in taxable cash accounts. IRAs, whether traditional or self-directed, are already tax-advantaged and can utilize little to no depreciation within the account.

Flexibility of SDIRAs

With an SDIRA, investors control their asset choices, selecting options like real estate or private loans that align with their financial goals. This contrasts with the limited mutual fund options in traditional 401(k) plans. Investors can tailor strategies for short-term cash flow or long-term wealth accumulation. The author planned their retirement timeline using an SDIRA, choosing investments that support retiring at age 50 while maintaining flexibility to adjust as needed.

SDIRAs allow investments in real estate, such as residential or commercial properties and raw land, which can generate income or appreciate over time. Hard money loans to developers offer 10-12% APR with property as collateral. Other options include assets like IRS-approved precious metals (per IRS Publication 590-A) and private company investments, even your neighbor's nephew's surefire next best thing startup, provided they comply with IRS regulations. We have a few private company investments in our IRAs, but they don't really cash flow, so we focus more on real estate and dividends/distributions for passive income.

Expanding Beyond Public Markets

Private assets differ from public ones in liquidity and return potential. Stocks offer quick liquidity, but due to ease of trading and frequency of valuations, they are more subject to market volatility. Their increased liquidity creates volatility that often lessens performance, as private markets as a whole tend to edge out public returns. The trade-off for private assets like real estate that provide higher, steadier returns often has longer exit timelines and high minimum investments. This is where our private real estate lending shines because they are private short-term collateralized mortgages giving higher returns with less risk and more liquidity, yield 10-12% APR, surpassing typical stock dividends.

Diversifying with public and private assets strengthens portfolios against market cycles. Non-correlated assets mean we hold some assets in a niche that we understand well and can manage expertly either as direct owners or as passive portfolio managers, and others that we rely on trusted experts to manage on our behalf.

Planning out how much money to invest in each type of asset is vital to a healthy diversification strategy.

Building a Balanced Income Strategy Across Tax-Advantaged and Taxable Accounts

Once you set up your first SDIRA, you'll liquidate a portion of your IRA to move those funds to other assets. You won't be taxed on this liquidation because you are just moving the funds from one custodian to another, not taking possession of them. Once those funds are transferred to the new SDIRA custodian, they will fund the investment you direct. They cannot give you investment advice, but they can advise on whether or not an investment is prohibited by the IRS.

Real estate investments inside an SDIRA reduce risk by spreading exposure across asset classes. For example, "hard money loans" secured by property collateral tend to remain stable during stock market downturns, protecting wealth. Additionally, combining stock dividends with real estate income creates multiple revenue streams, ensuring financial stability when consistent cash flow is necessary for retirement, whether early or not. For us, we hold index stock funds, dividend funds, as well as real estate payouts when we sell a property or collect interest on loans, providing consistent cash flow even when one market underperforms.

Diversification's goal is mediocrity, which is actually more attractive than it sounds.

Smoothing out volatility in favor of consistent income usually reduces the time it takes to manage a passive retirement portfolio, reduces stress, and gives basic income to allow us to focus on active pursuits, whether leisure or professional.

Taxable cash accounts, traditional IRA, and self-directed IRA investments can be spread across public and private markets, yield, and income strategies for a total wealth-building and preservation strategy.

The Benefit of an IRA Relies on Understanding Its Tax Benefits

If you are funding investments with any type of IRA and want to retire early, you will need to think about which investments to put in an IRA and which to have in taxable accounts so you can access them before age 59 ½, as well as what types of investments perform best inside a tax-advantaged IRA.

Real Estate in SDIRAs: Debt and Income vs. Equity and Depreciation

One of our personal major strategies for consistent income during our own early retirement is private loans. Because we cannot access our IRAs penalty-free yet, we keep enough in taxable accounts to live on now. We also enjoy taking on active income projects or ventures to lessen the need to access our passive funds and allow them to compound as much as possible. The passive income is a safety net that we can stretch with active income that is fun, interesting, or fulfilling. As we are still in our early fifties, we also use a tax strategy as real estate professionals to lessen the taxes we pay on those cash account investments until we can access our retirement accounts and all those tax benefits in our late fifties.

At 59 ½, we will be ready with well-funded IRA accounts. Inside an IRA, we heavily focus on private loans as interest is taxable income. As real estate professionals, our depreciation can offset that active income for now, but once we are more fully living out of our IRA income, we won't need that taxable protection any longer and just enjoy the benefits of passive real estate investing.

Inside our IRA, since we can't access them yet, the interest is reinvested and compounding from 10-12% APR up to 15% IRR over 5 years. This compounded return rivals most real estate equity deals where the investor shares in profits, but also risks sharing in losses without any collateral. Not only is the risk of equity investing higher than private lending, but inside an IRA, the depreciation cannot be used to offset the income, as it's already tax-advantaged. Consider carefully what type of account to use when choosing equity investments versus lender/debt investments.

Many SDIRA custodians say to use the account to fund the best deals you can find, and don't let the lack of depreciation affect that decision. However, knowing your unique tax situation allows you to make better financial decisions between using an SDIRA and taxable cash accounts once you find great private investments.

You have options: know how to use them to improve your ultimate goal of financial freedom.

Conclusion

A Self-Directed IRA empowers investors to diversify into real estate and private assets, reducing risk and generating passive income for retirement at any time after age 59 ½. Understanding that IRAs exist for investing tax benefits helps us commit to learning more about what types of accounts and investments are the best match for our own goals.