Why Smart Investors Should Consider a Self-Directed IRA (Versus an Actively Managed One)

It’s not uncommon for people to have actively managed IRA accounts — that is, paying a professional to manage their accounts for them. That makes a lot of sense if you know close to nothing about investing. Yet if you have any investment knowledge at all, a self-directed IRA is almost always the better choice.

There are at least five reasons why a self-directed (or self-managed) IRA comes out on top versus an actively managed one by a finance professional.

1. Investment Managers Are Expensive

As good a job as an investment manager might do with your retirement portfolio, they don’t come cheap. Their fees can be based on a flat fee, a percentage of your portfolio, or even on an hourly rate. The percentage basis is probably the most common form, and it can have a substantial negative effect on the investment returns that you receive on your portfolio.

Let’s say that the manager is earning you 10% per year on your IRA over a ten year period, but subtracting 3% for his fee. In that case, your true return is just 7% per year (10% minus the 3% fee).

If your IRA had $100,000 in it when the manager took over, it would grow to $196,715 after ten years. But if there were no investment fee, and you got the benefit of the full 10% return, it would grow to $259,374.

In effect, the investment manager is costing you nearly $63,000 over the ten year period, as a result of the out-of-pocket fees, and the lost compounding of investment income from the lower net return.

2. Investment Managers Don’t Usually “beat the market”

Compounding the fee issue is the fact that very few investment managers consistently beat the market over the long haul. If you’re lucky, a decent investment manager will match the market, and a significant few certainly will under-perform it.

Paying an investment fee to an investment manager who doesn’t beat the market hardly seems worth the trouble. Managing your own investments, you can at least match the market by investing your money in no load index funds tied to the S&P 500 index.

3. Many Investment Managers Don’t Customize Your Strategy

What you often see with investment managers is that most of their clients are invested in the same securities and funds as all the others. That makes investment management at least somewhat generic. They’re not necessarily building a portfolio designed to match your specific needs and investment temperament, but more likely basing it on a portfolio model that they’re using across the board.

This is hardly the custom investment portfolio that investors typically believe they’re getting as a result of paying an annual fee to an experienced investment manager. It might make the manager’s job easier, but it doesn’t exactly give you the kind of portfolio that you may want.

4. Practice Makes Perfect — Especially with Investing

One of the factors often overlooked when employing an investment manager is that it denies you the ability to grow in your investment knowledge. This is important because you will be investing money throughout your life.

And if you’re going to take part in any endeavor that will last that long, and have such an important impact on your life, you owe it to yourself to learn all that you can. That’s not happening when you’re relying on the services of an investment manager.

When your IRA is truly self-directed, you’re gaining important real-world experience about investing. Sure, it may not go especially well at the very beginning, but you have to make a few mistakes before you begin to truly learn what it’s all about. Once you get past those mistakes, you’ll find you can invest money just as well as any investment manager, but without all the fees.

5. Investment Resources for the Independent Investor

One of the big advantages for investors today is that the Internet offers so many resources to the small investor. Even if you know nothing about investments at the start, you can find exactly and precisely what tools you need in order to become the investment expert that you need to be.

As an example, a subscription to Morningstar can provide you with more information on investing than you ever knew existed. For about $200 per year you’ll have access to their reviews and ratings of mutual funds and stocks. The information that they provide is a resource that will help assist you in your investment decisions.

You can also set up your IRA with a discount online brokerage firm, that will enable you to trade investments and manage your portfolio with minimal transaction fees. For example, you can open an IRA with Ally Invest, where you can trade stocks at $4.95 per trade, or $9.95 on no-load mutual funds.

If you want to do something of a hybrid between a managed account and self-directed, you can also use an online wealth management platform like Wealthfront. They’ll set up your portfolio, make all necessary investment selections and rebalance your portfolio as necessary, all for a fee of less than 1% per year. It’s not quite a self-directed account, but it’s management for a lot less than individual investment managers charge.

With all the information, resources and tools that you have available, you should try to go the self-directed route with your IRA. The advantages over the long run are undeniable.