Retirement planning can feel daunting for many of us. We all have this idea of sipping Pina Coladas on the beach somewhere as we enjoy life without having to work. Unfortunately, that reality, especially in America, is not going to be the case for a vast majority of Americans. Americans are behind on retirement savings, straddled in debt, and lacking options. This doesn’t have to be you. Many different retirement vehicles can prepare you for a better tomorrow while giving you tax ride-offs today, whether that be through a 401k, Traditional or Roth IRA, pension plan, or a few others. These are great options for retirement but don’t give you complete control over how and what you are doing with your retirement money. Now, this isn’t a big deal for some of you, but if you want more control over how you invest, you do have another option available to you. Today we will talk about this little-known secret giving you more control over how you allocate your retirement fund, and it’s called a self-directed IRA.

Why Haven’t I Heard Of A Self Directed IRA Before?

Self-directed investing in an IRA has been allowed since the government first established IRAs in 1974. Before we go any further, we need to go over a vital component of any IRA which is the function of a custodian. Custodians are required in any IRA to maintain tax-deferred or tax-free status and essentially make sure you follow the government’s regulations.

The main reason it hasn’t received as much attention as its counterparts is most custodians who offer retirement accounts focus on traditional investment options like stocks, bonds, and mutual funds. The large firms that act as custodians usually don’t provide investment options in alternative because they are limited by the types of investments they offer at that particular firm. These firms make more money by providing investments in traditional assets that are easier to manage than non-traditional assets. Because of this fact, if you ask some of the larger custodians if you can invest in non-traditional assets, the answer you will most often get will be “no” or “I’ve never heard of that before.”

Why Self Directed IRA?

You might be thinking to yourself, what all does a self-directed IRA allow me to invest in? The answer is quite a bit longer than you might think. Self-directed IRAs give you greater access to how, what, and why you invest your money to meet your retirement goals. The IRS provides a list of prohibited investments in IRS publication 590. and All other investment types are allowed as long as the IRS rules are followed.

Allowable IRA Investments:

Non-Permitted Investments In An IRA:

Self-directed accounts do have a few additional rules to follow just by nature of having more control over your money that you need to be aware of.

The Arm’s Length Rule:

The IRS rule states that you and your investments must be at arm’s length. Essentially, the IRS wants to make sure that you can’t directly benefit from assets owned by the IRA today.

This might seem strange but remember the purpose of an IRA is not intended to benefit you now but rather your future self. You are planning for retirement, and that benefit will be received in the future. Any IRA transactions that benefit you personally are strictly prohibited. The golden rule is if an investment you have gives you a benefit today, it is not allowed. However, if it is a deferred benefit, that is permitted. Here are some common examples below:

• Personally Using IRA Property: Using real estate purchased through your IRA as a primary residence, vacation home, office space, or any space that could benefit you personally today is strictly prohibited.
  • You can purchase rental properties, but you can’t live or rent them to yourself or a disqualified person. (We will go over disqualified persons in the next section.)

• Receiving Personal Benefits from Your IRA: This is relatively straightforward, but you are not allowed to lend yourself or any disqualified person money from your IRA. You are also not allowed to pay yourself, a company you own, or another disqualified person to do work or manage any investment you own.
• Revenue and Expenses: The basic idea here is all income and expenses are received by and paid from the IRA. If your IRA owns a rental property, rents should be put directly into your IRA without touching your personal account, and all expenses should be paid directly from the IRA.

Disqualified Persons:

The IRS mentions disqualified persons frequently, and it is essential to know who those people are. The IRS states that a self-directed IRA may not buy an investment from, sell it to, or be involved with disqualified persons. Disqualified persons are your ascendants (grandparents and parents) and descendants (children and grandchildren).

Siblings, nephews, cousins, best friends, parent in-laws, aunts, and uncles are NOT disqualified persons and are perfectly fine to invest in and with.

In Summary:

Self-directed IRAs provide more flexibility to invest in different types of asset classes that have been traditionally not available to the everyday consumer. This option is not needed for everyone but can be very helpful depending on your term goals. Before opening an account, talk with a financial coach or advisor and see if this option makes sense for your retirement goals.

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Death, taxes, and inflation are three things in our lives that we cannot escape. The U.S. has gone through many brief periods of deflation, but for the most part, economic progress is accompanied by inflation. Often forgotten, inflation’s out-of-sight, out-of-mind force is being felt heavily today to a point we can’t ignore. The price of gas has increased year over year by 40%, and since the start of the pandemic, food prices have jumped almost 12%. It is affecting how we live our lives in an unprecedented way. Previous generations have had to battle inflation, but unfortunately, it is becoming more and more difficult as the price of goods has wildly outpaced the average salary increases in recent years. In last year’s annual shareholder meeting, Warren Buffet commented, “We are seeing very substantial inflation. We are raising prices. People are raising prices to us, and it is being accepted.”

It’s clear that inflation is here to stay. The only question that remains is what do we do with it? Here are some timeless tips to be able to better battle inflation and protect yourself from rising costs.

What Is Inflation?

Let’s start with the basics. Inflation is the general increase in prices and decrease in purchasing power of money. Things cost more; therefore, your money doesn’t purchase what it used to be able to. Time for a quick example. Let’s say the inflation rate is 10%, the $1.00 candy bar would cost $1.10 a year from now. Since the candy bar requires more money to purchase, it effectively makes your money less valuable. This may seem trivial when it comes to a candy bar, but when you think about all goods in the market being inflated, it becomes much more impactful. For example, if the inflation rate is 5% and you received a 3% raise from your company, you actually just received a 2% decrease in salary. You can quickly see why learning how to battle inflation is crucial in our pursuit of financial freedom.

The most common inflation indexes are the Consumer Price Index (CPI) and the Producer Price Index (PPI). Both the CPI and PPI measures change in prices over time for a given set of goods and services to provide an accurate picture of inflation in the economy.

Key Ideas:

• Inflation decreases the value of money, making things more expensive.
• The Consumer Price Index (CPI) and Producer Price Index (PPI) are designed to measure and report on inflation in goods and services over time.
• At its best, inflation can stimulate the economy and produce economic benefits such as boosting consumer demand which drives economic growth.
• Inflation affects everything from the cost of living, mortgages, borrowing rates, cost of doing business, and everything else in between.

Practical Steps To Battle Inflation:

When prices are rising, it is important to have tools in the tool belt to battle inflation effectively. We will cover four practical tips to apply to shield yourself from the effects of inflation.

1) Invest In Great “Defensive” Companies

The stock market as a whole typically does not like inflation. Inflation makes materials and labor cost more which ultimately hurts the earnings of the company. It is seemingly counterintuitive that investing through inflation would be a good idea. However, it is a great place to park your money during inflation, especially when you have a well-balanced portfolio with “defensive” sectors in it.

Defensive sectors are industries that tend to stay stable whether the market is doing well or not. Think consumer industrials, health care, energy, utilities, etc.. These industries have the ability to raise their prices and are essential in our day-to-day lives. The defensive sector has proven to do very well during periods of heightened inflation and has a place in most diversified portfolios.

2) Invest In Tangible Assets (Real Estate & Precious Metals)

Precious metals, namely gold, have long been the safe haven during periods of high inflation and economic instability. Precious metals sometimes move opposite to the U.S. dollar because they are denominated in U.S. dollars, which makes them a great hedge against inflation. In practical terms, if inflation goes up making the dollar less valuable, then gold goes up making gold more valuable. Example: If gold is worth $100 today with an expected inflation rate of 10%, then a year from now the gold we own would be worth $110 effectively negating the impact of inflation.

Similar to precious metals such as gold and silver, real estate tends to hold its value well during inflation. As prices rise, so will the property values and any associated rents with those properties. This increases the amount of rental income earned along with the overall value of the property.

Both investment classes make a great addition to your long-term portfolio, especially during periods when the economy is battling inflation.

3) Invest In Yourself

An investment in knowledge pays the best interest.

Benjamin Franklin

We clearly want to battle inflation and increase our purchasing power over time. An extremely effective way to accomplish this is by developing and investing in your talent. The great thing about investing in yourself is you are inflation-proof. You are effectively getting to purchase your education today for one rate but then can charge customers for the future rate without re-educating or reinvesting in yourself.

There are several ways to invest in yourself, from learning new skills online, going to school, or developing a side hustle that could turn into an entire business one day. Whatever you do today will have a compounding effect on your future. If only one thing in your life could compound, your skills and education can’t be too bad of a place to place your bets.

4) Practice Financial Discipline

Practicing financial discipline may be the easiest to explain on this list but the hardest to apply. It is so easy to fall into the habit of spending more than we make. When we do this, we are setting ourselves up for failure. Financial discipline is always good to practice, especially during high inflation.

“One of the great defenses to being worried about inflation is not having a lot of silly needs in your life.”

Charlie Munger 2004 Berkshire Annual Meeting

I think it is not a surprise that one of the most successful investors of all time doesn’t blame or look outside for answers but constantly searches for what he can do to best respond to the situation. The sad truth about inflation is we can’t control inflation. We can only control how we respond to it. We will be rewarded regardless of market conditions when we have practiced financial discipline.

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Hello and welcome to the wonderful world of passive income! There are many ways to generate passive returns, but my personal favorite is the stock market. The stock market can often feel like an overwhelming place full of gamblers and “gurus” alike. Because of this, investing in the stock market can feel incredibly daunting, exciting, scary, and everything else in between. What if it didn’t have to be? The stock market has ways of generating passive income that create consistent, safe returns over the long haul. If that sounds good to you, then you are in the right place! Today, we will differentiate between three types of funds: mutual funds, exchange-traded funds (ETF), and index funds. We will go over what they are, the benefits of each, and how they can be a part of your passive income strategy!

Purpose of Funds:

So let’s start with the basics; why the heck invest in a fund, and can it really generate passive income? When you hear about any type of mutual fund, index fund, or ETF, think of diversification. The basic idea of diversification is not putting all your eggs in one basket. When you have one asset, let’s say a stock, and that stock goes down, your entire investment goes down. If you have multiple stocks and one goes down, not as big of a deal. Diversification seems like a bright idea, right? The hard part of investing in the stock market for the individual investor whose job is not managing stocks is having a well-diversified portfolio of investments. The reason funds exist is so individual investors can have a well-balanced portfolio without the headache of selecting and maintaining an actively managed portfolio.

How Do They Work?

When thinking of funds, think of swimming pools. The people in the pool are the companies that make up the fund portfolio. The people outside the pool represent the investors in the fund. They can join the fund (pool), but they don’t have any say on what companies (or kids) are in the pool (portfolio). Lifeguards (fund managers) dictate what kids (companies) are in the pool and manage the pool entirely.

Mutual Funds:

A mutual fund is a professionally managed investment fund that pools money from all of its investors to purchase securities such as stocks, bonds, and other securities at the manager’s discretion. The combined total of all the assets in the fund is known as the fund’s portfolio. There are many mutual funds to choose from based on the kinds of securities they invest in, the investment objectives, the type of returns they seek, and the general timeline of investments.

When you buy a share of FB, it is both an investment for you and purchase of an actual company. A mutual fund works the same way. When you purchase a share of a mutual fund, you buy partial ownership of the mutual fund and its assets. The only difference between FB and a mutual fund is that FB is in the technology space while the mutual fund is in the business of investments.

Ways They Generate Income:

Investors earn a return from mutual funds very similar to that of buying a regular share of stock. Typically gains from the mutual fund are passed on to the individual investor to either reinvest for more shares or given as cash. Investors can earn income on a mutual fund in three ways.

1. Receiving dividends on stocks and bonds held in the portfolio.
2. Selling their shares in the market for a profit if the fund has increased in value
3. Capital gains the mutual fund passes down to the individual investors.

Fee Structure

Mutual funds will classify their expenses into either annual operating fees or shareholder fees, and these typically are around 3%. Mutual fund managers also typically charge commissions when shares are purchased. Commissions are classified as either “front-end,” which means fees are paid once you buy the shares, or “back-end,” which means expenses are paid when you sell the shares.

Key Takeaways

• Mutual Funds are actively managed meaning the manager of the fund is actively buying and selling securites in an attempt to maximize profits and minimize loses.
• Mutual Funds trade similiarly to a stock but they can only be purhased at the end of each trading day instead of during the day.
• Actively managed mutual funds tend to have higher fees and commissions than less active funds.
• Mutual Funds can generate consistent passive income even with the relatively high fees.

Exchange-Traded Funds (ETFs)

ETFs still follow a similar structure to that of mutual funds but with a few key differences.

• ETFs cost substantially less for an entry position because of the ability to buy a single share.
• Similiar to a stock, ETFS can be sold short. (We will go into what this means later in our investing series. If you are a long-term investor, this really has no impact on you.)
• Typically ETFs have favorable tax strucutres compared to that of mutual funds. Since ETFs are passive managed, the tend to realize fewer capital gains and thus less taxes.
• ETFs still have an expense ratio (commission) that is charged to invest. Vanguard’s S&P 500 ETF (VOO) has an expense ratio of .03%.

Investors earn a return from ETFs very similar to that of buying a regular share of stock. Individual investors receive the ETF gains as capital gains. ETFs give the investor more flexibility over the investment because you can trade it during the day. This offers investors a greater sense of liquidity, which is always a nice thing to have.

Types of ETFs:

There are three structures of ETFs which are Open-End Fund, Unit Investment Trust, and Grant Trust. They each serve a distinct purpose with rules about how they can invest.

Exchange-Traded Open-End Fund:

This is by far the most common ETF in the marketplace today. Open-End Funds have very specific diversification requirements on how much they can invest in a single stock. This protects you from having all your money in one company. Additionally, this structure gives management the most flexibility in how they manage the fund. Because of this, they can use strategies to replace an entire index without owning the entire index.

Exchange-Traded Unit Investment (UIT):

The main differentiator from the Open-End to the UIT is that a UIT attempts to fully replicate an entire index. For example, the SPDR S&P 500 ETF is structured as a UIT. They need to attempt to own every company and replicate the S&P 500 to the best of their ability. Also, UITs cannot reinvest dividends automatically, so they pay cash dividends quarterly.

Exchange-Trade Grantor Trust:

ETFs that invest in commodities prefer the Grantor Trust. The main difference is that in this structure, the individual companies own the underlying shares inside of the company. Instead of just owning a piece of the fund, you own a portion of what the fund owns directly. The investors get voting rights inside of this structure with the individual companies that the ETF owns.

Index Funds:

Index funds are passively managed ETFs or Mutual funds that match an index such as the S&P 500. They try to provide broad, diverse market exposure, low operating expenses, and very minimal portfolio turnover. They follow their specific benchmark regardless of market conditions. Warren Buffet has been recommending index funds for years touting them as the best investment most individual investors can make. The idea is that market on average will outperform any stock over time.

Sometimes less is more and with ETFs and mutual funds, they offer consistent safe passive returns. Just remember that the best investors of all time are dead people. They don’t try to time the market, they just let compounding do its thing. When markets get go down, like they will do from time to time it is crucial to stay the course. To quote the famous philosopher, “Just keep swimming.”

Buy the fear, sell the greed, and as always you got this!

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