Aging baby boomers have made retirement planning a top financial topic for 2017. Every day, some 10,000 baby boomers (those born between 1946 and 1964) are expected to retire and that pace is likely to continue for the next two decades. The baby boomer demographic consists of 79 million Americans who together account for roughly 26 percent of the US population. While at present only 13 percent of Americans are at retirement age (defined as age 65 or older), Pew Institute estimates that, by 2030, retirees will comprise 18 percent of the US population.
By their sheer numbers alone, baby boomers are redefining old age. As a group, baby boomers are retiring later and living longer than prior generations. The life expectancy of male baby boomer is six years longer than the previous generation and life expectancy for female baby boomers has extended by four years, according to Urban Institute analysis. One of the implications of living longer is that baby boomers will need extra savings to cover their additional years of retirement.
Unlike prior generations who relied on traditional pension plans to fund retirement, baby boomers will depend largely on savings they have accumulated in workplace retirement accounts. At present, about 30 percent of Americans born in the 1940s-1950s are covered by traditional plans, but only 11 percent born during the 1980s have these plans, according to Urban Institute. Because of these changes, baby boomers will need to invest more prudently, scrutinize fees more closely and avoid drawing down funds too quickly when compared to prior generations.
Not long ago pension fund managers made investment decisions for most Americans, but that began to change after the 2008 financial crisis, when investors began demanding better asset choices than just traditional stocks and bonds. Investor demand has led to the mainstreaming of alternative asset classes such as private equity and real estate. Once limited to big institutions and the very wealthy, individual investors have discovered the benefits of alternative assets and the industry has responded with a slew of new products that target average investors. Americans invested more than $6.2 trillion in alternative assets in 2016 and PriceWaterhouseCoopers expects that investment to more than double to $13 trillion by 2020.
When used appropriately, alternative assets provide individuals with many of the same benefits that made them attractive to institutions. These advantages include diversification, a wider set of investment opportunities and high risk-adjusted returns. In addition, thanks to new product offerings, individual investors can buy alternative asset products that have low initial investment requirements, immediate liquidity and management fees competitive with stock and bond funds.
One class of alternative assets that has become exceedingly popular is real estate and many baby boomers are investing in fixed income real estate products such as mortgage pool funds, which are created from a pool of real estate loans owned collectively by the fund subscribers. Mortgage pool funds provide the financing used by professional house flippers to purchase, rehab and flip homes. House flipping has made a strong comeback since the recession; industry sales volume hit a ten-year record in 2016 and house flipping profits surged to their highest levels since 2005. Investing in mortgage pool funds allows average Americans to participate in a booming housing market while also gaining other advantages that are described below:
Diversification is arguably the most important way investors can manage risks in their portfolios without sacrificing returns. Like other real estate-based assets, mortgage pool funds demonstrate a low correlation with stocks and bonds. This was evidenced by their performance during the 2008-09 financial crisis. The value of stocks and bonds plummeted, but most mortgage pool funds continued to produce 8-10 percent returns for their investors.
2. Steady Income
Most baby boomers nearing retirement seek investments that can deliver reliable income. Mortgage pool funds produce steady cash flow from the interest and principal payments made on the mortgages they hold. In addition, their income is generous when compared to meager bond fund yields and declining stock yields. Most mortgage pool funds returned more than 8 percent to their investors in 2016. Since its inception several years ago, the Socotra Fund has delivered annual returns ranging between 8 percent and 11 percent to its investors.
3. Minimal Risk
In addition to the risk mitigation that comes from diversification, mortgage pool funds have inherent advantages that further reduce risk. Each loan is secured by a physical asset, real estate, which retains value regardless of volatile price swings in the stock and bond markets. Mortgage pool funds provide an added layer of safety by maintaining a sizable spread between the loan amount and the value of the property that secures the loan. Conservative mortgage pool funds such as the Socotra Fund limit loan amounts to 60 percent or less of the property’s resale value. By maintaining this financial cushion, mortgage pool funds are able to recoup all of their investment if the borrower defaults and the property must be monetized through a foreclosure sale.
4. Broader Set of Investment Opportunities
Exposure to a much broader set of investment opportunities is a major appeal of alternative assets. Mortgage pool funds provide a vehicle for capitalizing on the benefits of real estate investing while avoiding the principal disadvantage of direct real estate ownership, i.e. lack of liquidity. Real estate is a huge sector of the US economy and has historically been the best hedge against inflation of any asset class. A robust housing market helped make residential real estate an especially attractive investment in 2016. Returns for single family home REITs exceeded 26 percent last year, according to REIT.com, while the stock market delivered a 12 percent return.
Many mortgage pool funds pay distributions monthly and investors are routinely earning high single-digit returns from these investments. This compares very favorably to other low-risk fixed-income investments such as government bonds, which are currently yielding less than 3 percent. In addition, by holding a mortgage pool fund in a self-directed IRA, investors can reinvest their monthly distributions for tax-free growth or collect monthly payments to help fund their retirement needs.