Investment crowdfunding is coming. But will you be able to invest?
If you’re like many Americans, you may not have a pot of money sitting around to sink into crowdfunding investments. Heck, most Americans don’t even have the suggested rainy day fund set aside. But many of us do have individual retirement accounts, or IRAs—about $14 trillion worth!
The problem is, IRA custodians (such as banks and brokerage firms) typically offer a pretty standard menu of investment options consisting of stocks, bonds and mutual funds. For anything more adventurous, such as real estate, an investment in a private company or a direct loan, you need a self-directed IRA. These self-directed retirement accounts have become increasingly popular for DIY investors, including locavestors, who want to shift money from the stock market.
(The SEC, it should be noted, warns of an increased risk of fraud due to the non-pubic nature of some alternative investments, particularly anything peddled at a “can’t lose” investment.)
Like conventional IRAs, self-directed IRAs are tax-advantaged, allowing your returns to compound tax-free. And, like their conventional peers, they are held by trustees or custodians—typically banks or custodial firms. What differs is the types of investment you can make from them and the fees charged for that privilege.
Self-directed IRAs offer a way to invest in alternative assets from Slow Money loans to crowdfunding and peer-to-peer lending, but to date they’ve been cumbersome and costly to set up. The IRA industry, like banking in general, is tied to decades-old technological infrastructure that bogs things down. Setting up a self-directed IRA involves printing, signing and snail-mailing stacks of documents to multiple parties—a process that can take up to 8 weeks. And the fee schedules charged by custodial firms can be complicated and steep.
That’s starting to change. IRA Services Trust Co., an IRA custodian, has introduced a simple and efficient way for investors to set up self-directed IRAs and easily invest in alternative assets including crowdfunding and p2p lending. The offering was announced at the recent LendIt conference. While the focus there was on the integration with crowdfinance platforms, individual investors can create an account or learn more at InvestNow. We talked to IRA Services Chief Strategy Officer Todd Yancey and strategic advisor and self-directed IRA expert James Jones about what this means for investors and the crowdfinance industry.
Amy Cortese: Tell me about this new product.
Todd Yancey: The IRA Services Cloud Platform (ISCP) is the industry’s first system to truly automate tax-deferred, micro alternative investing. In other words, it’s the first system that allows retail investors to effortlessly fund their P2P and crowdfunding investments through their 401(k) and IRA accounts. For p2p and crowdfunding platforms, it opens up more than $12 trillion held in retirement accounts.
AC: Why are alternative assets like those available through crowdfunding or marketplace lending an attractive option for retail investors?
Yancey: Today’s investor can no longer rely solely on traditional stocks, bonds, and mutual funds for growth and yield, and many have already begun seeking alternative investments on peer-to-peer marketplaces and crowdfunding platforms.
Alternative assets have become a critical component of an institutional investor’s portfolio—by some estimates, alternatives will grow to as much as a third of institutional portfolios in the next year or two. While qualified investors such as hedge fund managers, wealthy individuals, foundations and financial institutions are free to choose from an array of alternative products, including p2p loans and private company investments, it remains challenging for unaccredited “retail” investors to include these types of investments in their portfolios, especially in their retirement portfolios.
Many individual investors do not have a great surplus of regular savings. However, they do have investable funds available in their 401(k)s and IRAs. In order for these citizens to be on equal footing with America’s financially privileged, they need equal access to alternative products—that includes having the flexibility and freedom to use retirement dollars without it being overly cumbersome and expensive.
AC: Describe the current, conventional system of setting up and investing out of a self-directed IRA.
James Jones: Much like the legacy banking infrastructure that financial tech platforms are disrupting, the self-directed IRA industry also runs on manual, offline and non-integrated systems. Many self-directed IRA firms have a website where customers can provide initial account information, but everything after that is more or less manual. The investor has to print and mail documents to the IRA platform for review. Then they have to repeat the same process with an SDIRA custodian, and wait 4 to 8 weeks for the account to be processed. There is no data interface between the platform and SDIRA custodian.
AC: I looked into investing in alternative assets from my IRA a while back and finally gave up. In the age of financial innovation and disruption, why has it taken so long for the industry to modernize?
Jones: You’re not alone in your frustration. The reason it took so long is simply that the SDIRA industry was never set up to interface with institutional clients such as P2P and crowdfunding platforms. The industry was, and remains, a retail model focused on mom & pop real estate investors on a one-off basis. Until the crowdfinance industry emerged, the self-directed IRA industry never had the demand to invest millions into newer technology. Instead, they simply patched the existing antiquated infrastructure.
I draw the analogy of Blackberry dominating the mobile corporate communication market until Apple came along and obsoleted it, and Blackberry is still trying to patch its system today. As a new cloud-based SDIRA platform launches to redefine peer investing, the old school SDIRA providers are still talking about landing pages and patches.
AC: So how does the process work?
Yancey: ISCP is the technology that will be powering a number of crowdfinance platforms—we’ll begin announcing partnerships this week. The investor’s information is sent via APIs (a programming interface) to IRA Services, which handles the processing in the background. It’s all very seamless. You can also set up an account directly with IRA Services through our InvestNow product. Opening an account takes just 5 minutes. The entire process of account funding and directing the investment takes about a week.
AC: What are the investor fees and how does that compare to conventional SDIRA solutions?
Yancey: We charge a small percent of the value of the SDIRA. So a $1,000 account costs just a few dollars! There are no set up fees, asset fees or transaction fees, as there are at most conventional SDIRA providers. That makes it economical for even the smallest SDIRA accounts. We are the first and only SDIRA custodian that offers no minimums and allows for micro-investing.
AC: How do crowdfunding and marketplace lending platforms stand to benefit?
Yancey: Today, SDIRAs represent a mere 1% to 2% of the approximately $14 trillion retirement industry. Hardly anyone is getting tax-deferred or tax-free (ROTH) alternative investment returns. Until now, SDIRA solutions weren’t capable of integrating with the high-tech crowd-based platforms, so the crowdfinance platforms would only accommodate SDIRAs at an investor’s request. With ISCP, these platforms will now be able to truly scale as they seamlessly tap into the $14 trillion retirement market.
AC: Is this purely a technological issue, or is there a legislative piece to this? For example, in the UK, where crowdfunding and peer-to-peer lending are more established, the government has specifically allowed individuals to invest in those platforms from their retirement accounts.
Yancey: It’s a technological issue. Under the IRS Code 4975, almost any asset excluding art, jewelry, collectibles and Sub-S corps are permitted in retirement accounts.
AC: Any sense of the pent up demand for this among the investing public?
Jones: The president of one of the largest P2P platforms once told me, ‘Retirement accounts could be 50 percent of our business if someone could find a way to automate and integrate with us.’ We believe that the combination of a modern, cloud-based SDIRA and the emerging ‘crowd-centric’ retail alternative products have the potential to transform financial services in much the same way that the 401k and the mutual fund did 35 years ago.