Should You Buy Risky Assets in your 401(k)?

Potential changes could be coming to your workplace retirement plan. President Trump signed an Executive Order that would pave the way for riskier assets to be included in 401(k) plans. The Order asks the Labor Department, which oversees workplace retirement plans, along with the Treasury Department and the Securities and Exchange Commission, to determine what regulatory changes need to be made to allow plan participants to invest in certain types of risky alternative assets like crypto, private real estate, and private equity inside of their 401(k) retirement plan.

Currently, there is no law or rule that precludes alternatives from being among the menu of choices inside a plan, though under the Biden Administration, there were restrictions made in 2022. Additionally, plan sponsors owe a fiduciary duty to participants, meaning that the investments have to be in the best interest of those who are using the retirement plan. Because these are risky investments, many sponsors have opted to keep them out of plans for fear that participants who get burned using them might sue the sponsor.

What Is Private Equity, Exactly?

Private equity is essentially buying a stake in a company that is not yet publicly traded on a stock exchange. Private equity firms pool money from investors to acquire companies, restructure them (sometimes ruthlessly), and hopefully sell them for a profit, years down the road. Historically, institutional investors, like endowments, pension plans, and wealthy individuals, have poured money into private equity.

What Are the Risks and Rewards of Alternative Investments?

Private equity and private real estate investments tend to be harder to buy and sell, because your money is typically locked up for 7 - 10 years. Additionally, they are usually more expensive than other investments inside of retirement plans, a 2 percent management fee plus 20 percent of profits (aka “2 and 20”), vs. 1 percent for managed funds or less than 0.1 percent for an index mutual fund. The managers of these funds say that the higher risk, volatility and fees are justified by the potential to make money. Critics contend that the biggest beneficiary of this rule change will be the companies that offer them, not plan participants.

Should You Buy Risky Assets in Your 401(K)?

If alternatives become available in your plan, treat them like any risky investment or company stock, don’t put too much money in these funds, maybe a maximum of 5-10 percent of your total account value. Remember that trying to find the next “hot” investment is really a fool’s errand. The magic of retirement plans is being consistent and letting time work for you. For most investors, the fundamentals remain unchanged: contribute consistently, diversify broadly with low-cost index funds, and let time compound your returns.