401(k) Plans Opening Up to Private Equity: Is It Right for You?
This year has seen numerous changes to retirement accounts, from existing legislative fixes made last year to new legislation responding to the COVID-19 crisis, and they have the potential to completely upend the retirement industry. Perhaps the biggest one was the elimination of the stretch IRA, an attempt by the federal government to get its hands on more tax revenue by speeding up the distribution of inherited IRA assets.
Additional changes Congress made included increasing the age at which investors are required to start taking required minimum distributions (RMDs) to 72. And with the onset of COVID-19, Congress authorized a temporary moratorium on RMDs in 2020, and allowed investors to take penalty-free distributions from their 401(k)s. But now a new regulatory change is providing even more changes to retirement accounts.
For the first time, ordinary investors will be able to invest the assets in their 401(k) plans in private equity. Previously, private equity investments were considered too risky for normal investors, and one had to be a qualified or accredited investor in order to invest in private equity. That meant satisfying minimum standards for wealth, and in practice it meant that only the really wealthy could invest in private equity firms. Now the floodgates have been opened, and trillions of dollars worth of retirement assets are now able to invest in private equity. But is that a good idea for investors?
Advantages of Investing in Private Equity
Private equity firms take on a great deal of risk, but the rewards on the other side can be great. The firms generally focus on acquiring companies that are underperforming, turning them around so that their business improves, then selling them after a few years. The returns on investment can be substantial, and many investors in private equity firms have made good amounts of money through their private equity investments.
But because these investors had to be well off to begin with, the returns on private equity have made the already rich even richer. Now private equity is opening up to a larger number of investors, in the hope that some of those gains may now trickle down to ordinary investors.
Diversification is always beneficial for an investment portfolio, and in that respect being able to invest in private equity opens up new classes of investments for investors with 401(k) plans. Most likely, these new opportunities won’t involve investing in actual private equity firms, but in funds that pool investments in private equity firms. It remains to be seen, however, just how many 401(k) plans will end up offering private equity investment options, and how many investors will avail themselves of the opportunity to invest in private equity.
Disadvantages of Investing in Private Equity
One of the major disadvantages to private equity investments is the potential for loss. And because the risks taken on by private equity firms are so great, the risk of loss is therefore greater. Private equity investments also aren’t required to publish the same detailed financial data that publicly traded companies are, so investing in private equity deals requires either trusting that the financial data you’re presented (if you’re presented any) are true or doing your own research.
That’s one reason only accredited investors were allowed to invest in private equity previously. Because they were better off financially than most investors, they not only were deemed better able to take a big loss, but they were also considered better educated and more knowledgeable about the risks of such investments.
With stock market mania so rampant in the US right now, many retail investors are looking to hit it big, so the temptation to invest in private equity might be quite strong. But with an economy on the verge of recession, even private equity won’t be able to withstand a hit from a major recession, and that could lead to big losses.
Since most 401(k) plans will probably start standing up their private equity options in the midst of a recession, many investors will be tempted to invest their 401(k) assets in private equity as part of a search for yield. We saw that in the aftermath of the 2008 financial crisis, as low interest rates sent investors across the board looking for yield. That’s grown to include inherently risky junk bonds, which are seeing more investor interest than they have in decades. And if the search for yield incentivizes workers to start looking to private equity, it could dramatically raise the risk profile of their retirement investment portfolios.
Are There Better Alternatives?
What if there were a way to benefit your retirement savings by investing in an asset that could lower your risk exposure, diversify your portfolio, and provide you with solid long-term investment gains? You may laugh and think there’s no such holy grail of investing, but you’d be wrong.
Over the past two decades, gold has been one of the best-performing assets around, gaining average annualized returns of 10% per year, versus less than 5% for stock markets. Gold also is a great investment to diversify an investment portfolio and hedge against financial crisis, inflation, and economic upheaval. And because the gold price isn’t as volatile as stocks and commodities, it’s been trusted by investors as a store of value for centuries.
Best of all, investors who already have a 401(k) or other tax-advantaged retirement account such as a 403(b), TSP, IRA, SEP IRA, etc. can roll over their existing retirement assets into a gold IRA with no tax consequences. A gold IRA offers all the same benefits as a conventional IRA, is subject to the same IRA rules as any other IRA, but allows you to invest in physical gold coins or bars, an option that 401(k) plans and most IRAs don’t allow.
If you’re looking for better gains for your 401(k) assets, or if you’re looking to protect your existing assets in the face of a coming recession, it’s worth looking into a gold IRA. The 401(k) to IRA rollover process works just the same as any other rollover of retirement assets, only with a gold IRA you’ll be benefiting from an investment in gold. Why take the risk of major losses by trying to invest your 401(k) assets in private equity when a gold IRA offers you both the stability and wealth growth that you want?