When it comes to a 401(k) account, most savers simply choose a target date fund and leave it that.
Now, thanks to a rule change from the Trump administration, those retirement vehicles could soon get a lot more complicated. It’s likely to lead to new risks (and perhaps new rewards) for savers.
Managers of 401(k) plans now have the ability invest in private equity. In other words, your 401(k) could soon take stakes in private companies.
The goal, according to Labor Secretary Eugene Scalia is to allow investors to “gain access to alternative investments” and “ensure that ordinary people investing for retirement have the opportunities they need for a secure retirement.” The Department of Labor laid things out in a letter that says putting 401(k) money into private-equity funds would not “violate the fiduciary’s duties” of certain retirement plan sponsors.
But some experts see a big downside.
Barbara Roper, the Director of Investor Protection at the Consumer Federation of America, said the “significant risks” associated with private equity investments haven’t been adequately addressed.
“By the Department of Labor's own admission, these are investments that are more complex, more opaque, less liquid, more difficult to value, with often higher costs than the investments that are traditionally offered through retirement plans,” Roper said in an interview with Yahoo Finance.
You ‘could do much, much worse’
The DOL letter means that a 401(k) manager could now decide to invest in private-equity funds that previously were not accessible. These funds traditionally have been reserved for the wealthiest traders and institutional investors. They typically come with higher risk since private companies are not required to disclose nearly the same about of data with the SEC as public companies do.
The new rule could be tempting for average savers who may now have a roundabout way to get a piece of a company – like SpaceX or AirBnB – that’s still private. The American Investment Council, which represents the private equity industry, has lauded the change, saying it will strengthen Americans’ retirement security.
One thing that remains up in the air is how quickly the managers of the big retirement plans will embrace their new options. Companies like Vanguard and Fidelity have not yet offered comment on the new guidelines. Another outstanding question is whether these plans would list private-equity funds among the options for savers to choose from, or whether private equity would simply be mixed into existing funds.
Alexis Leondis, an opinion columnist for Bloomberg, recently asked if the move is worth the risks. “Many plan sponsors don't have the sophistication or background in alternatives to fully understand the complicated structures of many private equity funds," she wrote.
Roper said that “the dispersion of returns in the private-equity fund space is huge, much broader than it is in the public markets.” And while the returns for over-performing private equity funds can, indeed, beat the public markets,“if you get in a below average fund, you could do much, much worse," she said.
An example of a big downside in private equity fund is SoftBank’s Vision fund. That fund recently announced losses of $24 billion after failed investments in WeWork and OneWeb.
According to a 2018 study by the Stanford Center on Longevity, about half of American workers are saving money through a retirement plan at work. Access to and participation in 401(k)s is much lower among younger workers. A report from the National Institute on Retirement Security found that two-thirds of working millennials have nothing saved for retirement.
A second rule change, over financial advice
A second change is coming soon and is expected to relax restrictions on the advice financial professionals give about their retirement investments.
The change, passed by the SEC last year with a compliance deadline of June 30, says brokers must act “in the best interest of the retail customer at the time the recommendation is made, without placing your financial or other interest ahead of the retail customer’s interests.”
SEC Chairman Jay Clayton has said that the change is part of "raising the standard of conduct for broker-dealers," while he has discussed in interviews how the best interest standard is different than a fiduciary standard.
According to the Consumer Federation of America, the move could lead to an understanding that investment advisers are not true fiduciaries. A fiduciary is someone legally obligated to act in the best financial interests of the clients they are advising.
Roper says that this potential new rule gives broker-dealers and investment advisers “virtually unlimited ability to act as advisers, while simultaneously failing to regulate them accordingly.” They can now “mislead their customers into believing they are getting trusted, best interest advice when they are actually getting investing recommendations biased by toxic conflicts of interest,” she said.
Roper appeared as part of Yahoo Finance’s ongoing partnership with the Funding our Future campaign, a group of organizations advocating for increased retirement security for Americans.
Consumer Federation of America is an association of non-profit consumer organizations. More than 250 groups – from local agencies like the New York City Department of Consumer Affairs to private groups across the country – participate in the federation.
All of these changes may not be noticed by certain savers who are often encouraged to take a “set it and forget it” approach to their retirement. If their 401(k) provider does end up getting involved in private equity, advocates like Roper say that "the promise of improved performance is not necessarily met by the reality."
Ben Werschkul is a producer for Yahoo Finance in Washington, DC.