Self-directed IRAs allow you to choose your own investments based on what you know best. However, the responsibility of due diligence also falls on your shoulders and is critical to the overall success of assets you acquire.
Why is due diligence important?
The main reason you should perform due diligence on any investments before acquiring them is to avoid fraud. No one is bullet proof as far as fraud goes, but the more you investigate a potential asset along with the people involved, the better your chances are of ferreting out the bad apples and benefiting from the good.
You also want to ensure you don’t accidentally transact with disqualified persons. For example, your IRA cannot purchase an asset from or sell an asset to yourself, your spouse, your lineal descendants or lineal ascendants. This rule also applies to investment advisers, managers, fiduciaries, and anyone else providing services to your IRA. Dealings with corporations, partnerships, trusts, or estates in which disqualified persons have a 50 percent or greater interest are also not allowed.
What are the best ways to perform effective due diligence?
Research the investment thoroughly. Make sure the asset is viable and not a grand Ponzi scheme someone’s peddling or a junk piece of property. Ask questions; request financial information if it’s a private equity, stock, crowdfunding, or other option that would hopefully have statistics attached. Find out who else is involved, if possible. Google it.
Ensure the parties you are working with are on the up-and-up. Not only do you need to investigate the aspects of the investment itself—you also need to fully vet the parties involved. From the bank to the realtor to the broker to the individual seller—get access to their credentials. Is the attorney involved reputable? Is the realtor respected? How experienced is the broker? Are they listed in good standing within their industries? You can Google that, too.
Seek the advice your own trusted CPA, realtor, attorney, or financial advisor. Even though your research may prove the persons facilitating your potential investment are legitimate, you should still enlist the help of your own trusted advisors. These people may have solid knowledge (good or bad) of the others you’re dealing with. And if they don’t know, they have better access to get reliable information on people within their industry. Perhaps they have merely heard whispers of negativity within their peer groups about the asset and people involved—which may help you determine whether you buy in or not.
When purchasing real estate investments, explore the property. Is it a raw land parcel in an area that is under consideration for eventual development? Or is it a swamp that will only ever benefit the alligators? Is that piece of rental property in an area that generally attracts consistent, reliable tenants? Or is it located in an undesirable area where many homes are vacant, run-down, or riddled with crime? Whether you’re looking at commercial or residential real estate, determining these elements is critical to the success of your return on investment.
Ask other investors. Joining investment clubs and attending investor networking events is beneficial in many ways. Meeting others whose interests are in line with yours increases your resource base of knowledge. All share secrets and tips, success stories and failures to help each other out. If you have a particular asset in mind, broach the subject and get the opinion of others. You never know—someone in one of these groups could possibly have experience with the asset you’re considering and the people involved. Any news helps arm you with the information you need to move forward or step away from the opportunity.
Self-directed retirement plans offer account owners great freedom and flexibility in choosing alternative assets to build income in their portfolios. However, as the saying goes, freedom is not free—so, you have to do your part in committing to perform due diligence on your investments. Sometimes it’s easy; other times it can be exhausting. In any case, it’s worth your time. The success of your financial future depends on it.
If you have questions about this article or wish to learn more about self-directed retirement plans, please contact us.