Bonds or Dividend-Paying Stocks – Which are Better For Your Self-Directed IRA?

Regardless of your overall investment outlook, your preferred investment types, or even the size of your retirement portfolio, there’s a good chance that won’t at least part of your nest egg to be in assets that generate a regular income stream.

This is often a common scenario when someone enters retirement, and needs to begin living off of what they’ve accumulated in their various retirement accounts. Rather than having to sell off investments and reduce the size of their overall portfolio, many individuals choose investments that generate an income stream and can cover some or even all of that individuals or retirement expenses.

Differences in Risk

Bonds are generally considered to be a safer investment than stocks in terms of risk to capital. Bondholders receive their interest payments before the company can pay any stockholder dividends, and bondholders are generally near the front of the line in getting any type of payout if the company experiences any significant financial difficulty.

This generally results in greater market volatility and price fluctuations of stock investments over bond investments. Investors who are looking to make trades with a relatively short or medium term time frame will need to take these risk differences into account.

Differences in Potential Upside

In the most general of terms, stocks are considered to have a greater upside potential as compared to bonds. Bondholders are limited to receiving their stated interest payments, and those payment levels won’t grow over time, in contrast to the dividend payments at a common stockholder might receive. Furthermore, bondholders won’t share in the growth of the company in the same way that stock investors will.

But that certainly isn’t to suggest that it’s impossible to realize significant capital gains through bond investing. Remember that as current interest rates go up and down, the price of any given bond to instrument will tend to vary inversely to that interest rate change. This means that as current rates fall, the value of a bond will tend to increase.

Cash Distinguished

It’s important to note that when we’re analyzing and evaluating the relative pros and cons of bonds and dividend paying stocks, we’re still very much keyed into the investment elements of those asset classes. In other words, even where the primary investment goal is current income, we still evaluate and ultimately select our investments giving consideration to whether we can also realize gains on those investments too.

Bonds and dividend paying stocks should therefore be distinguished from cash or investments such as bank CDs. In general, the purpose of those investments is not to generate current income (particularly with the historically low interest rates we’ve seen over the past number of years), but liquidity and security of principal.

3 Reasons Why Self-Directed IRAs are Worth the Time and Energy

You’ve likely found that setting up a new IRA is usually a quick and easy process. After all, many traditional IRA custodians use online forms and (in the case of a bank or brokerage that’s acting as custodian) these custodians generally allow you to instantly transfer money to fund your new IRA from other accounts you may have at the same institution.

But setting up a self-directed IRA isn’t that much more time consuming than an IRA with a more traditional custodian. It’s true that it might take a little extra time to fill out an extra form or two, or to fund your account. But what’s more important is that the benefits of having a self-directed IRA instead of a traditional account far outweigh the small amount of extra time and energy you’ll have to expend.

1.         The Opportunity for Greater Gains. If you have an IRA with a bank or brokerage as the custodian, then you’re going to be significantly limited in the types of investments you can choose for your account. Traditional IRA custodians generally limit investments to stocks, bonds, mutual funds and bank CDs. While there’s nothing inherently wrong with this selection of investments, many individuals would like to be able to invest at least a portion of their retirement funds and investment classes that have an opportunity for higher rates of return.

With a self-directed IRA with a custodian such as Quest Trust Company, you’ll also be able to invest in precious metals, real estate, private equity, mortgages and other negotiable interests, and even privately held companies.

2.         Great Opportunities for Real Estate Investing. As noted above, a self-directed IRA with a custodian like Quest Trust Company gives you the opportunity to invest in real estate. For many individuals, their largest single investment asset (apart from their primary residence) is their IRA. This means that the IRA balance you’ve accumulated over the years can be put to use investing in the wide variety of opportunities in the real estate market.

For example, it’s possible to use a self-directed IRA to invest specifically in the property or piece of real estate that you intend to live in during retirement. Some self-directed IRA account holders have used their accounts to purchase a future retirement property, rent that property out to third parties (thus generating additional income to their account), then simply take a distribution of the entire property from the account once they retire. This can provide great peace of mind for individuals who may be worried about their living expenses and situation once they enter retirement.

3.         Pinpoint Targeting of Your Investing. Let’s say you’ve researched a particular market or industry or type of product and want to invest in it. With a traditional IRA, unless you’re able to identify a publically traded company with exposure to that market (assuming such a public company exists), you’re frozen out of that investment option. With a self-directed IRA you can invest in private companies in that market, make loans to those companies, and various other types of related transactions.

In short, the self-directed IRA will give you investing opportunities that simply don’t exist elsewhere.

How to Compare Real Estate Investments with Other Investment Types

real estate investmentIt can be financially risky for an investor to become overly committed to a single investment class, Becoming too focused on a particular type of investment makes it difficult to maximize the performance of an investment portfolio because not all investment options are being considered.

While the single most important factor in each investment choice you make is likely to be the expected or anticipated investment performance, most investors are also likely to consider overall portfolio diversification as well as suitability of any particular investment to their individual risk profile. Comparing investments within a particular investment class (for example, one stock versus another stock) is relatively straightforward, but it can be more challenging to compare across different investment types.

Since real estate is a particularly popular investment for individuals that have a self-directed IRA with a custodian such as Quest Trust Company, let’s examine some of the factors that are relevant to comparing real estate investments to other investment types.

Liquidity. Liquidity is perhaps the biggest distinguishing factor between real estate and many other types of investments. When you hold investments in publicly traded stock, for example, it’s easy to open or close investment positions whenever the market is open. Some investors may even trade in and out of a particular stock multiple times within a given trading day.

In contrast, the timing of a transaction to buy or sell real estate is generally measured in days or weeks (and often even months). It’s therefore important to assess your liquidity needs before making any real estate investment. Investors or retirement savers with significant other assets, or whose investing timeframe is very long) are generally in a better position to bear the potential downsides of relatively illiquid real estate investments.

Leverage. Using leverage (i.e., borrowing money to make an investment) is generally much more common for real estate investments than other investment types. With the proper use of leverage an investor can significantly boost their investment returns, but only if your total cost of borrowing is low.

Furthermore, in the context of a self-directed IRA, using leverage to purchase real estate can trigger certain unrelated business taxable income (“UBTI”) liabilities for the IRA. If the UBTI rules are not fully understood, an investor who uses leverage to purchase real estate in a self-directed IRA can find themselves in a very bad financial position trying to come up with the funds to pay those taxes.

Expenses and Taxes. Real estate investments generally involve a much higher level of ongoing expenses. Whereas investments such as stocks and mutual funds may not cost you anything beyond your brokerage commissions to buy and sell, owning real estate comes with property tax liabilities, maintenance and upkeep fees, as well as possibly even management fees. These expenses are generally tax deductible against any income you receive on the property, but the value of this deduction will generally be lost within a self-directed IRA. When trying to compare real estate with other investments, be sure to fully consider all associated expenses.

Regardless of the size of your self-directed IRA, there’s a good chance that real estate can help you meet your retirement goals. Understanding how to compare real estate investments with other investment types is the first step in making the right financial decisions.