In a significant move for retirement investors, President Trump has issued an executive order that will allow individuals participating in 401(k) plans to invest their savings in private assets. This directive mandates that both the Department of Labor and the Securities and Exchange Commission develop guidelines for incorporating private-market investments—such as private equity, venture capital, hedge funds, real estate, and potentially gold and cryptocurrency—into defined-contribution plans. Proponents argue that this change would provide opportunities for diversification beyond traditional stocks and bonds, potentially enhancing returns over time. However, experts caution that these investments come with their own set of risks that savers should be aware of.
Understanding Private Assets
Private assets encompass a wide range of investment types, each with varying levels of risk and return. Lisa A.K. Kirchenbauer, a senior advisor and founder of Omega Wealth Management in Arlington, Virginia, emphasized the importance of comprehending these differences before making any investment decisions. She referenced the advice of renowned fund manager Peter Lynch, who advocated for investing in areas where one has knowledge. Without a solid understanding of private assets, Kirchenbauer recommends sticking to more traditional investment options.
Liquidity Considerations
One key distinction between private assets and traditional investments like stocks and bonds is liquidity. Private assets are generally less liquid, meaning they cannot be easily liquidated for cash when needed. This characteristic makes them less suitable for investors with shorter time horizons—such as those approaching retirement who may need to start withdrawing funds from their 401(k) accounts. Kirchenbauer advised that investors must familiarize themselves with the liquidity rules governing these assets before proceeding. For those who plan to maintain their investments over the long term, even into retirement, private assets may offer a more viable option.
Shifting Portfolio Standards
BlackRock CEO Larry Fink has proposed a new approach to retirement portfolios, suggesting a shift from the traditional 60/40 allocation of stocks and bonds to a more modern 50/30/20 model, which includes a significant portion of private assets. In his annual letter to clients, Fink highlighted that pension funds have successfully integrated these types of investments for many years, resulting in their superior performance compared to 401(k) plans. He noted that this difference of about 0.5% annually may seem small but can accumulate significantly over time.
Regulatory Guidance Needed
While private assets are currently permissible in retirement accounts, 401(k) providers often lack familiarity with these investment options. The president’s directive aims to encourage regulators to provide the necessary guidance to facilitate the integration of private assets into retirement plans. However, this initiative may be daunting for many American workers, who often have limited knowledge of what their 401(k) investments entail.
The Rise of Target-Date Funds
Many employees enrolling in employer-sponsored 401(k) plans are defaulted into diversified target-date funds based on their expected retirement timeline. For instance, Vanguard reported that over 80% of its 401(k) participants utilized these funds last year, with a significant amount of contributions directed toward them. A target-date retirement fund allows investors to choose a year for retirement and invest in a mutual fund that adjusts its asset allocation over time, typically becoming more conservative as the target date approaches.
Innovative Investment Options
In this evolving landscape, BlackRock has launched a target-date fund that incorporates private credit, private equity, and other alternative investments. This fund aims to enhance annual returns by approximately 0.5%, potentially increasing the total value of 401(k) investments significantly over a 40-year period. Other major players in the retirement services sector, such as Empower and Voya Financial, are also exploring partnerships to offer private equity and credit options within their retirement portfolios.
Democratizing Access to Private Investments
Cary Carbonaro, a certified financial planner and author, noted that private assets have historically been accessible only to wealthy individuals and institutions. The inclusion of these investments in 401(k) plans represents a democratization of alternative investment opportunities. However, she cautions that, while private assets may offer higher long-term returns and some protection against inflation, they might not be suitable for the average investor due to their complexity and potential liquidity issues.
Potential Risks and Costs
As private equity enters the realm of retirement accounts, there is concern that costs for investors could increase. This is particularly noteworthy given the recent trend of decreasing fees in 401(k) plans, largely driven by the rise of low-cost index funds. Carbonaro pointed out that private funds often come with additional performance fees and costs that could diminish net returns. The challenge remains whether employers or plan fiduciaries will be willing to take the risk of offering these investment options to their employees.
