August 2, 2021

Inflation, Self Directed IRAs, and Real Estate Investing

What is Inflation? 

Everybody has a rough idea of what inflation looks like. Prices go up, your money starts becoming increasingly less valuable, and it becomes harder to buy standard necessities. In reality, this is surprisingly close to the official Federal Reserve definition

“Inflation is the increase in the prices of goods and services over time. Inflation cannot be measured by an increase in the cost of one product or service, or even several products or services. Rather, inflation is a general increase in the overall price level of the goods and services in the economy.” 

The Federal Reserve’s metric of inflation is called the Consumer Price Index (CPI). It measures the prices on a bundle of standard goods and services like housing, groceries, and transportation. It’s that simple. If you read a headline that inflation is going up, it means that the CPI is rising.  

Inflation and Retirement Investing 

Inflation has an effect on almost every element of the economy. Prices rise, consumers buy less, and people start changing the way they save or invest their money. The effect of inflation on the stock market is a particularly confusing one. Different studies have shown different results and it would seem that there are a number of factors that must be considered. The specific point in the economic cycle, an investor’s ability to hedge, and the government's current monetary policy can all play a significant role. For the most part though, the numbers seem to indicate that “real returns” from the stock market (actual returns minus inflation) are at a low point during high inflation periods. For those whose retirement investing is focused on the stock market, this could be a real concern. However, it is often mitigated by the fact that stock-based retirement investing can span a number of economic cycles. In that case, the individual ups and downs won’t matter as much as the overall growth or decline. 

Inflation and Self Directed IRAs 

How does inflation affect a Self Directed IRA? Most Self Directed IRAs are not based on the stock market, which means they need a different kind of study. Since a Self Directed IRA will typically focus on one specific asset, the response of the Self Directed IRA to inflation will be directly tied to the response of that asset. Currently the most common Self Directed IRA assets include real estate, cryptocurrency, precious metals, and private placements. In this review, we will be focus on real estate in a Self Directed IRA and how it responds to economic changes. 

Real Estate in an IRA and Inflation 

Real estate can take many forms in a Self Directed IRA. Investors place retirement funds in rentals, fix-and-flips, commercial spaces, and REITs. An average self-directed investor will typically start off with a small multi-family and manage 3-4 rental units. If inflation is expected to rise, is that investment track still a good idea? The answer will usually be “yes!” Inflation puts a damper on new home purchases. Interest rates go up, mortgages are harder to get, and many consumers will continue to rent until conditions improve. That means rentals can see a surge, rent prices can go up, and a multi-family can continue to perform profitably. 

However, there is a category of rentals that will not do well during inflation: vacation units. During times of rising inflation. Consumers have less cash available and expensive vacations will often be one of the first luxuries to be crossed off the list. In such a case, you can see prices start to plummet as vacation units face ever greater vacancies. This could be especially true in a situation like Covid where consumers were not able to travel even if they wanted to. 

Get Educated 

There are no crystal balls for inflation. The best you can do is get educated as to general trends, and then hedge your Self Directed IRA with assets that can perform in varying conditions. Speak with your financial advisor and plot a course that makes sense for your goals. Learn, diversify, and then manage accordingly. It’s still the best route to take for a Self Directed IRA. 

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