President Trump has enacted an executive order that paves the way for 401(k) retirement plan participants to invest their savings in private assets. This new directive mandates the Department of Labor and the Securities and Exchange Commission to create guidelines that will enable defined-contribution plans to include investments in private markets, which encompass private equity, venture capital, hedge funds, real estate, and potentially gold and cryptocurrencies. Proponents argue that this transition could enhance diversification beyond traditional stocks and bonds while also offering the potential for higher returns over time. However, this shift comes with significant risks that retirement savers need to consider.
Private assets encompass a variety of investment types, each presenting unique levels of risk and potential returns. Lisa A.K. Kirchenbauer, founder of Omega Wealth Management, emphasized the importance of understanding these differences before making any investments. She cautioned that individuals should refrain from investing in unfamiliar areas, recalling the advice of renowned fund manager Peter Lynch, who famously stated, “own what you know.” If investors lack comprehension of their investments, sticking to traditional options may be wiser.
In contrast to publicly traded stocks and bonds, private assets tend to be less liquid, meaning they cannot be easily sold when cash is required. This characteristic makes them less suitable for individuals with a short investment horizon, such as those approaching Required Minimum Distributions (RMDs) or transitioning their 401(k) to an IRA due to job changes. Kirchenbauer advised that investors should familiarize themselves with liquidity constraints; otherwise, they should avoid these investments. For those with a longer investment timeline, including during retirement, allocating a portion of their portfolio to private assets could be more appropriate. She suggested starting with a modest allocation of 5-10%.
BlackRock CEO Larry Fink has expanded on this notion, proposing a shift from the traditional 60/40 investment split between stocks and bonds to a more diversified structure of 50/30/20, which would include private assets such as real estate, infrastructure, and private credit. In his annual client letter, Fink highlighted that pension funds have historically invested in these asset classes, while 401(k) plans have not kept pace. He pointed out that this discrepancy contributes to pensions outperforming 401(k)s by approximately 0.5% annually—a seemingly small percentage that accumulates significantly over time. Although private assets are already permissible within retirement accounts, Fink noted that many 401(k) providers lack familiarity with them.
The president’s directive aims to guide regulators in helping these providers navigate the complexities of private asset investments. Nevertheless, this development poses a perplexing challenge for many American workers who might not fully understand the specifics of their investments when they enroll in employer-sponsored 401(k) plans. Often, employees are defaulted into diversified target-date funds based on their expected retirement timelines. For example, at Vanguard, more than 80% of 401(k) participants utilized target-date funds last year, with about two-thirds of contributions directed toward these funds—a record high. Target-date retirement funds are designed to adjust their asset allocation automatically as the target retirement date approaches, typically transitioning to a more conservative investment mix.
BlackRock has already entered this market by announcing the launch of a target-date fund that will incorporate private credit, private equity, and other investment types, with a goal of boosting annual returns by an additional 0.5%. This increase could potentially result in approximately 15% more savings in a 401(k) over a 40-year period. This new fund will be offered through Great Gray Trust, a firm managing over $210 billion in assets, which specializes in retirement investment options. Additionally, Empower, the second-largest U.S. retirement services provider, has formed alliances with prominent private investment managers and custodians, including Apollo Global Management and Goldman Sachs, to offer private equity, credit, and real estate options in its retirement portfolios later this year.
Cary Carbonaro, a certified financial planner and author, highlighted the historical exclusivity of private assets, which were typically available only to high-net-worth individuals and institutions. The inclusion of these assets in 401(k) plans democratizes access to alternative investments. However, she urged caution, noting that while private assets may provide higher long-term returns and better protection against inflation for certain types, they may not be suitable for the average investor. The long-term locking of private assets with limited liquidity could conflict with the flexibility needs of participants, and many investors may find it challenging to grasp the intricacies of their investments or the factors driving performance.
Furthermore, with the introduction of private equity into retirement accounts, there is a risk of associated costs rising for investors, especially after a trend of decreasing fees in 401(k) plans due to the growing popularity of low-cost index funds. Carbonaro pointed out that private funds often incur performance fees and additional costs that can diminish net returns. She expressed concern that many individuals may not even be fully aware of the specific stocks or bonds within their investments, as these assets are typically reserved for more experienced investors. It remains to be seen if employers or plan fiduciaries will take on the responsibility of offering these investment options.
