Trump Wants Private Equity in 401(k)s: What It Means for Your Retirement Savings
Key Takeaways
- President Donald Trump on Thursday signed an executive order that could open the door to allowing private equity, cryptocurrencies, and other alternative investments into 401(k)s.
- Advocates say the change would give workers the ability to diversify their portfolios and increase total returns by investing in fast-growing startups.
- Some experts warn that the complexity and opacity of private equity may pose a risk to investors and that education efforts are needed.
President Trump on Thursday signed an executive order that could significantly expand everyday investors’ access to some of the more opaque and riskier corners of financial markets.
The order directs the Department of Labor to reevaluate the fiduciary duty rules that discourage defined-contribution retirement plans from investing in private equity and other alternative investments. It also instructs the Securities and Exchange Commission and the Treasury to revise regulations to facilitate the investment of retirement funds in alternatives.
Private equity has long been a mainstay of some retirement plans, including pensions and self-directed IRAs. The 20 global pension plans with the largest PE allocations invested more than $700 billion in PE funds last year, according to data from S&P Global.
Trump’s executive order opens the door for private equity to receive a portion of the $12.2 trillion U.S. workers have parked in defined-contribution plans like 401(k)s.
The Benefits of Private Equity in a 401(k)
“I think there’s a lot of alignment between the goals and the structures of retirement accounts and the goals and structures of private market investments,” says Brianne Lynch, Head of Market Insight at EquityZen, an online marketplace for shares of private companies.
Retirement accounts like 401(k)s are designed to encourage long-term investment. Plan participants are, in most cases, penalized for withdrawing funds early, which can incentivize the kind of buy-and-hold investing that Lynch says is expected in illiquid private markets.
“When we look at pre-IPO investments, these are investments we expect people to hold for five to seven years,” says Lynch. “It’s not the money that you need in a year to put a down payment on a house.”
Advocates of allowing PE in 401(k)s often point to the consistent outperformance of private market investments compared with publicly traded assets. Vanguard predicts the median private equity portfolio will return nearly 9% annually over the next decade, outperforming the median global public equity portfolio by 3.5 percentage points and the median 70/30 portfolio—70% stocks and 30% bonds—by nearly 3 percentage points.
Trump’s order could also expand everyday investors’ access to fast-growing startups. Today, the world’s 1,600 unicorns can tap ample private capital, allowing them to stay private far longer than was once the norm, according to Lynch. As a result, accredited investors with access to private markets have booked eye-watering returns that even the luckiest investor would be hard-pressed to recreate in public markets.
The ‘Black Box’ Risks of Private Equity
Big returns often come from taking bigger risks, and in private equity those include liquidity and price discovery risk, according to Andrew Herzog, Associate Wealth Manager at The Watchman Group.
“There is no price action on illiquid private investments. No one knows at any given moment what it could be worth,” says Herzog. That could cause problems for an investor who wants to borrow against their 401(k) or simply needs to state the precise value of their assets.
Limited price discovery could also undercut the argument that PE diversifies a portfolio, argues Herzog. For example, while tariffs wreaked havoc on the stock and bond markets earlier this year, home prices held steady. But that doesn’t necessarily mean real estate was a hedge against volatility. “There’s no active buying and selling of my home, so you don’t know what the price was actually doing during those two months,” says Herzog. “To just simply report on something less often doesn’t make it diversified,” he added.
Private companies are also not subject to the reporting requirements that securities laws mandate of public companies. Companies like blood-testing start-up Theranos and cryptocurrency exchange FTX seemed like promising investments until they were exposed as frauds. Doing due diligence on private companies is difficult, says Herzog, “because it is such a black box. You would have to take the word of the owners and founders of that small firm that they’re telling the truth.”
Herzog also notes that few 401(k) participants are familiar with the ins and outs of private equity, considering it’s been inaccessible to the average American. Plenty of people still struggle to understand the major differences between stocks and bonds, he says. “If you add another investment opportunity, the risk is people don’t know what they’re getting into.”
Wise Structure, Education Are Key to Success
Whether private equity is appropriate for one’s retirement account will largely depend on how the Labor Department and other regulators act on Trump’s order, according to Herzog.
“They’ll have to come up with the ways of educating the public, writing the right material and disclosures,” he says. For example, if regulators develop rules that enable plans to bundle private investments in vehicles like mutual funds or exchange-traded funds, that could cut down on liquidity risk and make portfolio management easier.
“As long as it’s done correctly… then it absolutely could be worthwhile” for the average American, says Herzog. “I’m optimistic, but I really need some more specifics and structure from the Department of Labor.”