Private Equity In Your 401(k)? What This Means For Retirement Savers

Thomas H. Ruggie, ChFC®, CFP®, Founder & CEO, Destiny Family Office.

Regulators and policymakers have been looking for ways to diversify retirement portfolios and improve long-term returns, and they may be getting their wish. In August, President Trump signed a declaration that effectively allowed private equity and other alternative investments to be included in 401(k) plans. With around $12 trillion sitting in 401(k) plans nationwide, even small shifts in allocation could create huge waves.

For decades, retirement accounts have leaned on public stocks, bonds and mutual funds because they are liquid, transparent and relatively simple to regulate. Private equity, on the other hand, was the world of institutional investors and the ultra-wealthy, with long lock-up periods, higher fees and more complex structures. Now there’s a push to “democratize” these opportunities, giving everyone—in theory—access to these investments as part of their retirement plans.

Why Now?

Diversification beyond public markets is the biggest draw. Adding private equity can give ordinary savers access to innovative and fast-growing private companies, with growth opportunities that were once reserved for university endowments or billionaires’ portfolios.

If you choose the right funds, the potential for higher returns is undeniable. Over the past few decades, private equity has outperformed benchmarks like the S&P 500 on average. But that’s still a big “if,” since the average hides a wide variance. Some funds do incredibly well, while others fail spectacularly.

Risks And Costs

First, private equity is less liquid. Your money is locked up for longer periods, and these firms operate with long-term horizons. Fees are also higher; you could be looking at a structure where a firm charges 2% upfront, 1% annually and 20% of gains on positive sales. That’s much more expensive than most 401(k) offerings. Add to that the lack of transparency and the possibility of underperformance, and you have a situation that could expose plan sponsors to even more lawsuits than today. (Under the current retirement plan structure, legal challenges over underperformance and excessive fees are common.)

If participants don’t understand what they’re buying, they may make poor decisions. It’s not as simple as “buy low and sell high.” Left on their own, many people make bad money decisions, like believing—despite constant warnings—that past performance is some kind of guarantee of future results.

Target date funds may be a useful way to avoid disaster for many investors. Nearly half of retirement savers are already in them, and as these funds adopt alternative strategies, they could help smooth out risk profiles. Letting professionals manage the allocation of private equity within a diversified target date fund might be the most practical way to benefit without undue risk.

Looking Ahead

It could take a year or two before private equity options become widely available. The first adopters will likely be larger, well-known firms like Blackstone or Goldman Sachs, whose products already fit comfortably within regulatory expectations. Over the past few years, some have created evergreen funds, ongoing vehicles that offer greater liquidity than traditional private equity models. With these, you don’t have to wait for a fund to open, close and then mature five or 10 years later to see your money again. That structure is far more compatible with a 401(k) plan. The lion’s share of the opportunity will probably go to these major players, and frankly, that’s a good thing for the average investor. The timing may actually be ideal.

I believe opening private equity to 401(k) plans will ultimately be good for investors in terms of performance and diversification. But it’s not without danger. The combination of higher fees, longer lock-ups and opaque structures means this transition must be handled carefully. Regulators and investors will have to move deliberately to ensure that the retirement portfolio landscape remains safe and solid. The next few years will show us whether we’ve chosen wisely.

The information provided here is not investment, tax, or financial advice. You should consult with a licensed professional for advice concerning your specific situation.

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