Employers currently exclude private assets from 401(k)s due to their legal fiduciary duty. This responsibility compels them to avoid the high risk, complexity, and valuation difficulties of illiquid investments.
This move could significantly alter the investment landscape for millions of Americans, offering the potential for higher returns but also introducing greater risks.
What We’re Seeing
The executive order directs the Department of Labor to redefine what constitutes a “qualified asset” under the Employee Retirement Income Security Act of 1974 (ERISA). This change aims to provide individual investors with access to the same types of investments as large institutional investors, like pension funds and endowments. While the rulemaking process will take time, the order signals a major shift in retirement savings philosophy, moving toward a model that embraces a wider range of asset classes.
Key Signals
Desire for Higher Returns:
Proponents argue that including alternative assets in 401(k)s could lead to higher long-term returns. Historically, private equity has outperformed public markets. For example, from 1990 to 2022, private equity has seen an average annual return of around 13%, compared to about 10.6% for the S&P 500. This has the potential to significantly boost retirement savings for many Americans.
Increased Risk and Complexity:
Critics raise concerns about the higher risks, complexity, and costs associated with alternative assets. Private equity investments are often illiquid, meaning they can’t be easily sold, and they come with higher fees than traditional mutual funds. Cryptocurrencies are known for their extreme volatility. This raises questions about whether the average 401(k) participant can make informed decisions about these complex investments.
A Win for the Private Equity and Crypto Industries:
The private equity and crypto industries have long lobbied for access to the vast pool of capital in 401(k) plans. This executive order is a major victory for them, potentially funneling billions of dollars into their funds. It also aligns with the interests of a growing number of younger, tech-savvy investors who are interested in digital assets.
Slow Adoption and Fiduciary Concerns:
Even with the new rules, adoption of these new investment options is expected to be slow. Employers, who have a fiduciary duty to act in the best interests of their employees, may be hesitant to offer these riskier assets due to potential liability. Major retirement plan providers like Fidelity and Vanguard will need to develop new products and educational materials to support these new offerings.
Emerging Structural Trend
This executive order reflects a broader trend of “democratizing” finance, where technologies and regulatory changes are making a wider range of investment opportunities available to the general public. For decades, access to high-growth private markets was limited to institutional investors and high-net-worth individuals. Now, we are seeing a shift toward a more inclusive investment landscape, though it comes with the challenge of ensuring that individual investors are adequately protected.
Potential Investor Implications
For private market investors, this could lead to a surge in demand for private equity and venture capital funds. Asset managers who can create products suitable for the 401(k) market will have a significant new source of capital.
This also creates opportunities for companies that provide the infrastructure and services to support these new investment options. This includes everything from financial technology companies that can create platforms for accessing alternative assets to educational services that can help investors understand the risks and rewards.
Sources:
Private Equity is Coming for Your 401(K): How to Protect Yourself – Investopedia
Trump opens the door for private equity and crypto as 401(k) retirement plan options
Trump wants your 401(k) to access crypto and private equity. Here’s what to know.
Democratizing Access to Alternative Assets for 401(K) Investors – The White House
Workers do not need private equity in their 401(k) plans – Morningstar
