Trump Eyes 401(k) Overhaul for Alternative Investments
Retirement Accounts Could Soon Feature Private Equity and Crypto
President Trump’s recent executive order aims to broaden retirement savings options, proposing to allow 401(k) plans to invest in so-called alternative assets like private equity and cryptocurrencies, potentially reshaping how Americans save for their future. This move could significantly impact the $5 trillion private equity industry, which has long sought access to the nation’s retirement funds.
Shaking Up Traditional Portfolios
The directive could inject higher-risk, potentially higher-reward investments into the typically conservative investment menus offered through employer-sponsored plans, including 401(k)s and 403(b)s for educators. While some savers might welcome the diversification and potential for robust returns that alternatives can offer, experts caution about inherent risks and complexities. Simon Tang, head of U.S. at Accelex, a private markets specialist, expressed optimism, stating that these investments have “matured into a strong-performing asset class delivering excellent long-term returns.”
What the Executive Order Entails
The order directs the Labor Department and other agencies to redefine what qualifies as a permissible asset within 401(k) regulations, which are governed by the Employee Retirement Income Security Act of 1974 (ERISA). ERISA mandates that employers prioritize their employees’ best interests. Currently, most retirement plans consist of stocks and bonds, with lesser allocations to cash and commodities.
Crucially, workers would retain the ability to stick with traditional investments and opt out of any new alternative strategies introduced to their plans.
Timeline and Adoption Hurdles
The implementation of these changes is expected to take time, potentially months or longer, due to the intricate nature of ERISA regulations. Following the Labor Department’s new guidance, major retirement plan administrators like Fidelity and Vanguard will need to develop suitable investment vehicles. Furthermore, employers will require time to revise their offerings.
Analysts from Pitchbook anticipate a slow adoption rate, citing concerns about “cost, transparency and complexity.” They noted that while asset managers are keen to access the $12.5 trillion in defined contribution assets, these factors could hinder widespread uptake.
Understanding the Risks of Alternatives
Alternative investments, particularly private equity, carry unique risks. Investments in non-publicly traded companies lack the transparent, real-time pricing and daily performance updates common with stocks. Tang explained the difference: “When it comes to investing in stocks, retail investors are used to instant pricing, clean data and daily performance updates. Private markets are a different ballgame. There’s no real-time information, no ticker and no standardization, just fragmented documents and unstructured formats.”
Cryptocurrencies, while offering more pricing transparency, are known for extreme volatility. Despite this, their popularity is growing, with approximately one in four Americans reportedly investing in crypto, according to Security.org data from 2023.
Performance Potential vs. Costs
While alternatives can offer outsized returns, there’s no guarantee. Bitcoin, for example, surged 135% last year, significantly outperforming the S&P 500’s 24% gain. However, in 2022, Bitcoin dropped 65% while the S&P 500 fell 19%, illustrating the potential for sharp downturns. Conversely, a study indicated that private equity investments yielded an average of 13.5% over a decade, surpassing stocks’ 9.7% and bonds’ 1.9% returns for the same period.
Investors must also consider that alternative investments often come with higher fees, including management costs, which can diminish overall returns. Pitchbook explained that these increased costs stem from the more involved processes of acquiring and managing private companies, which are passed on to fund investors.
