It’s no secret that the stock markets are in a bit of a funk. All those “rational” investors who were piling into equities in January are now nursing their wounds after experiencing one of the worst first quarters on record. For those looking for diversification and stability, it might be time to look into alternative investments.
Here are five reasons why now is the time for a Solo 401k that makes alternative investments.
1. The Stock Market Is Unpredictable And Has Been Highly Volatile Q1 of 2022
Do you recognize a bear market when you see it? A bear market happens when no matter how much due diligence you perform on your security choices, the big bear devours your picnic anyway. That is what has been happening with the security and exchange markets since December of 2021. Generally, a bear market is defined as when security prices in a market declined by more than 20% from recent highs.
Bear markets can be highly volatile. They might recover quickly in several weeks or a few months. In uncertain times, bear markets are just as likely to last for years and even stretch out over a decade.
In early 2022, the big hungry bear devoured a whopping $7 trillion in market value from the blue-chip stocks in the S&P 500 (18%). You never know, that could just be an appetizer or the soup course. Look at what has been happening to the tech stocks on the Nasdaq. Values are down across the board at about 27%. Clearly putting it into bear territory. These include big-name stocks that you recognize: Apple, Microsoft, Amazon, Google, and Facebook which are all deep in red territory for the year. Netflix is falling off the charts with losses of more than 70%.
There is an official Fear & Greed Index that gauges what is driving stock market movements (0-100 with levels below 50 showing panic in the market). The index has been hovering for months at a level below 10. There must be alternative investments available that operate in a more rational manner than fear and greed!
2. Alternative Assets Are Often Uncorrelated With The Stock Market, Providing A More Stable Investment Opportunity
The self-employed and certainly the Millennial generation have shown a strong preference for thinking outside the box. Not only about what they want from their work-life but just as much about how they want to invest their money. The way many want to invest their money is not in the traditional investments — stocks, bonds, and cash. Today’s investors are much more interested in alternative investments that they have control over rather than markets that control the investment. Investments that do not follow the ups and downs of global mass markets. Instead, they prefer investments they understand and can influence such as real estate in their local market or Bitcoin which is intended to be independent of government and financial institution policies.
Alternative investments are also known as alternative assets for a good reason. Many people prefer assets because these are real resources instead of zeros and ones in Wall Street computers. These can be physical assets that you hold in your hand like gold bars (a hedge asset). Or contractual obligations backed by physical assets such as a mortgage on a house that a homeowner lives in.
A Solo 401k account is your individual path away from the stock markets to taking full control of alternative investments that are more predictable, reliable, and that you understand. Alternatives offer a variety of liquidity, industry, and time horizons.
3. Alternative Assets Can Offer Higher Returns Than Traditional Investments Like Stocks And Bonds
Alternative investments offer greater portfolio diversification, lower overall risk, with the potential for higher returns. Self-made millionaires and other rich people did not get that way by working 9 to 5 and saving a small amount of their paycheck with the expectation that a 10% (or lower) rate of return on their savings would make them rich. But these financially savvy people do tend to have several things in common.
- They have some cash or liquid assets to make investments. You may already have that in a current or previous employer 401k that you can roll into a Solo 401k.
- Some do have a few stocks, bonds, and mutual funds as part of a diverse portfolio. A Solo 401k can also make these traditional investments.
- They have an active income from a business, deals, and projects. The Solo 401k brings huge tax advantages for people working as sole proprietors, small business owners, independent contractors, and freelancers. The rich know how to minimize their taxes and maximize earnings.
- Much or all their income is passive – meaning they don’t work for it 9 to 5. With a business, passive income can come from something like an e-commerce store. Solo 401k earnings are also passive from sources such as repeat rent checks that come every month.
- They don’t leave idle money in a savings account paying a rate of interest less than the rate of inflation. They make alternative investments to spread out the risk and to take advantage of a better chance to earn high rates of return.
A key reason they make alternative investments is that these are not tied to stock markets. Different economic factors drive stock markets and many alternative investments. For instance, when inflation is high and the Federal Reserve raises interest rates to slow inflation, the stock markets suffer because it becomes too expensive to borrow money to grow huge institutional businesses. But inflation is a friend to the real estate rental market. The income from rents will rise with inflation but your costs to own the rental house remain the same with either a fixed-rate mortgage or outright ownership of the property. Your passive income increases but not your costs. This is why many alternative investments are used as a hedge against inflation.
Alternative investments are not exotic investments. These are assets that all of us are familiar with, and people understand some of them very well. These are also fascinating to learn more about because it helps explain how the rich get even richer by taking advantage of almost unfair opportunities. Here are only a few examples of alternative investments that you can hold in a Solo 401k:
- Private Equity – investing capital in private businesses that can include venture capital, growth opportunities, and buyouts
- Private stock offerings, private placements
- Judgments and structured settlements
- Tax liens secured by real estate
- Car loans secured by a vehicle
- Accounts receivable – buying a company’s accounts receivable at a discount
- Equipment leasing
- Commodities – natural resource investments including oil, agriculture, timber, etc.
- Foreign currency
- Add your own thoughts to the list
- Of course, real estate is included and is highly popular with Solo 401k investors
Real estate itself is highly diversified to include residential, commercial, and retail property that your Solo 401k can invest in as an individual or with a partner(s). How diversified is real estate? Just look at the one category of commercial real estate that can be further divided into 10 highly profitable subcategories:
- Mobile home parks
- Other specialties
Even apartments are further subdivided into low-rise, mid-rise, high-rise, student dormitories, etc. A popular investment strategy among Solo 401k investors is to pool money through an LLC partnership to invest in highly profitable mid-size to large-size apartment complexes.
Alternative investments are the key to building strong and diversified investment portfolios. However, you do need to learn some basics about liquidity, industry, risk level, and market trends. This is how you mitigate the overall risk to your portfolio while increasing your returns.
4. Bond Yields Are Still Relatively Low
When the stock markets take a dive, investors with few alternatives flood into the bond market. But how much financial sense does this make? Sure, bonds are a more secure investment because they pay a known interest rate. However, during inflationary times that needs to be a reasonable interest rate just to tread water. Right now, interest rates on bonds are well below the inflation rate. We all know that interest rates have been at historic lows for a couple of years – that’s what made stocks attractive for a while and why Solo 401k real estate investors got great mortgage rates.
The stock selloff means trillions of dollars are fleeing into the bond markets. Institutional corporations and governments benefit from a rush into bonds because when everyone wants the security of a known interest rate, bonds are sold at the lowest interest rate that investors will offer. Of course, that means the investors are getting very low rates even though the Federal Reserve is hiking interest rates. Chalk that up to be because we are coming off historically low interest rates.
In fact, as the stock market sell-off persists (mid-May 2022), the yield on the benchmark 10-year Treasury note dropped nearly 5 basis points to 2.866% (1 basis point is equal to 0.01%). The yield on the 30-year Treasury bond moved lower to 3.034%. Neither stocks nor bonds are a safe haven during times of uncertainty.
5. Many Alternative Investments Provide A Hedge Against Inflation, Giving Your Portfolio More Stability
Alternative investments in a diversified portfolio are a long-term strategy. This becomes particularly important during times of rising inflation and market volatility. After more than a year of severe economic turmoil, last year showed a path of economic revival as vaccines released us from lockdowns, copious fiscal stimulus, and the lifting of restrictions on activities fueled the economy. The resurging growth was the strongest in nearly four decades.
However, the pace of reopening the economy brought new and unique challenges that include bottlenecks in global supply chains, lack of skilled labor, and the war in Ukraine with skyrocketing fuel prices that affect almost every sector of the economy. The result has been a surge in prices for various goods and services — better known as inflation. Inflationary prices that not long ago were thought to be temporary but now look to be with us for a long haul.
Now is the time for alternative investments that hedge against inflation and may even thrive during inflationary. Real estate, private credit, commodities, and other opportunities have a history of performing well during periods of inflation. Homes and commodities are essentials that people cannot get along without. Higher prices will have to be paid even when tighter budgets mean cutting back on non-essentials.
Commodities are also essential inputs into various goods and services that must keep pace with inflation. Even non-essential commodities such as gold have a known history of hedging against inflation. Still, commodity investors should consider political and regulatory risks that could cause volatility in supplies and deliveries.
The entire purpose of higher interest rates to tame inflation is to slow the amount of money being loaned. This makes private credit more appealing to mid-market companies that have less access to traditional bank financing. Loans with reasonable interest rates can be collateralized with senior, first-lien positions against the assets of a company. These loans can be structured to “float” with increases or decreases in a short-term benchmark rate — a feature that improves inflation protection.
These and other alternative investments can enable investors to reduce the negative impacts of inflation while enhancing portfolio performance and diversification.
Set Up Your Self Directed Retirement Plan and Start Investing In Alternatives
Ongoing fluctuations in the stock and bond markets along with a breakdown of investor confidence in corporate America are driving the demand for alternative investments with greater choice for retirement accounts. Investors now realize they can invest in real estate and other non-traditional assets using their retirement accounts.
Setting up a Solo 401k retirement plan is easy and allows for tax-deductible contributions much larger than an IRA or employer 401k. Importantly, it puts you in control with access to a world of alternative investment options.