Risk Aversion Is Holding Retirement Funds Back

In late September, the Department of Labor issued a new advisory opinion clarifying that certain lifetime-income funds in 401(k)s can qualify as default investments even when they include alternative assets (that is, investments that are not publicly traded like stocks, bonds, mutual funds, or ETFs).

That step follows multiple developments in August: President Trump issued an executive order on “democratizing access to alternative assets,” allowing 401(k)s and similar workplace retirement plans to invest in real estate, digital assets like cryptocurrencies, and non-exchange-traded securities like private equity. Trump’s Department of Labor also rescinded Biden-era guidance against alternative assets in 401(k) plans, arguing it had a chilling effect on the market.

This led to a string of voices on the Left decrying the risks. Phyllis Borzi, the former Assistant Secretary for Employee Benefits Security under the Obama Department of Labor, claimed that such investments are “virtually impossible” for investment advisors to understand and that interpreting the new rules will lead to a “reduction in fiduciary standards.” Others, like Sen. Elizabeth Warren (D-MA), have been complaining that the fees on these investments are often higher.

These claims are overblown: Critics who lament fees ignore the fact that they’re often outweighed by the expected return of these investments. And while the chance of losing money is real, it always has been in the stock market as well. Not only is it not a cause for alarm, but we should welcome the change.

Defined-benefit plans like pensions have long invested in private equity, including those offered as benefits to government employees. This was also already possible in self-directed individual retirement accounts (IRAs) and there has been no sign of mass impoverishment due to the additional freedom. On the contrary, risky asset purchases have been modest: the Government Accountability Office estimated in 2020 that only 2% of IRAs held unconventional assets, suggesting that savers were not widely gambling their assets but perhaps may want the ability to further diversify their portfolios.

The changes also bring opportunity not only for investors to earn higher returns, but for low-cost resources like robo-advisors or retirement plan advice engines to meet new investor demands. There are signs that the private sector is already meeting the moment. In September, investment firms Goldman Sachs and T. Rowe Price announced a collaboration to provide diversified retirement investments like target-date funds that include some alternative assets like private equity. In other words, the market is already incorporating these assets in appropriately small amounts to diversify clients’ investment portfolios.

This expansion opens individuals to the same investments big institutional players and public-sector employees with pension plans already have access to. But it also gives some hope for further loosening of investment restrictions in other areas. The Social Security Trust Fund, for example, remains locked almost entirely into government bonds that guarantee stability but deliver weak returns. Even a modest allocation to higher-return assets like the stock market would increase its solvency for future generations, just like more investment flexibility will help future retirees build wealth for their own future.

This doesn’t mean jumping wholesale into crypto or other risky investments as critics may claim, but instead diversifying over both low-risk and high-risk securities. Risk-aversion masquerading as prudence has long deprived ordinary Americans of the tools that pensions and endowments rely on. That imbalance is finally shifting and we should welcome it and push to extend it further.