The views presented here do not necessarily represent those of Advisor Perspectives.
Retirement savers have plenty of questions about a recent executive order that opens a path for alternative investments, such as private equity, real estate and digital assets, in 401(k) plans. And one advisor shares why individuals have good reason to take pause, once these investment options come to bear.
In early August, President Trump signed the executive order, “Democratizing Access to Alternative Assets for 401(k) Investors,” which directed the Department of Labor, within 180 days, to review and clarify fiduciary guidance related to alternative investments under the Employee Retirement Income Security Act (ERISA) of 1974.
Additionally, the Securities and Exchange Commission was guided to “facilitate access to investments in alternative assets by participants in participant-directed defined-contribution retirement savings plans,” the executive order states. Following on from the executive order, this week the U.S. Department of Labor proposed a rule that would protect fiduciaries from lawsuits related to the inclusion of alternative investments should they use the appropriate prudence and analysis when deciding to invest funds in alternative assets.
“The intention behind why this is happening is trying to democratize access to alternative investments,” said Chelsea Ransom-Cooper, co-founder and chief financial planning officer at Zenith Wealth Partners, of the Trump initiative.
But having the option doesn’t mean alternative investments will be the right choice for all, or even most, 401(k) investors.
“As with anything, personal finance is personal, so pick the things that make sense for you. And if it doesn’t make sense, leave it out,” Ransom-Cooper said.
“I think there should be some pause as people may sign up for things they are unfamiliar with — and it could be a risk to their retirement portfolios. I’ve had some clients who were calling with concerns about this (executive order). We let them know this is an option. This isn’t a requirement,” Ransom-Cooper said.
Private Equity Considerations
When thinking about the inclusion of private equity investments, in particular, in retirement accounts, policymakers would need to assess the risk vs. rewards for plan participants. There’s also the logistics of including individuals who don’t have long-term investment horizons, or long-term employers, in these funds, Ransom-Cooper shared.
“I think it’s going to be really interesting to see how they will tactically implement this,” she said. “Private equity investments are typically a longer-term investment and relatively illiquid. People also change jobs frequently and are rolling over their retirement funds to new accounts, so if that private equity option is not available in a participant’s new retirement account,” she is curious what would happen.
“We also know that private equity and hedge funds can have a ‘2 and 20’ fee structure. This means typically there is a 2% annual management fee just to gain access, and 20% of any profits are also provided to the fund managers,” Ransom-Cooper explained.
As a result, fund managers, or alternative investment firms, are often incentivized to take on riskier investments due to the potential payoff. But “for the retail investor, it may not be the best fit. This is why (private equity) may make sense for an accredited investor, but may not make sense for the majority of Americans who are trying to invest in their 401(k),” she said.
The Role of Plan Participants vs. Plan Sponsors
While it will take some time for any new rules to be implemented, Ransom-Cooper shared some initial thoughts on how the industry could protect Americans’ retirement investments and savings.
“Some of the core people would be the plan sponsor, or the employer — whoever is the fiduciary on that (investment) plan. Then you also have the plan administrator and the investment adviser of the plan. All will have the duty to see if they want to include those alternative funds or not,” she said.
“And if they do decide to include it, it’s up to each person to hopefully connect with their own financial advisor and check in, at least annually, to see what makes sense and how their funds are performing.”
Zenith Wealth Partners largely works with traditional wealth management clients, but they also advise some small business owners, helping them set up 401(k) plans for employees, among other services, Ransom-Cooper shared.
“Because we see both sides, I’ll be able to see when (these alternative investments) actually start to become an option in plans. That will be helpful to know so we can actually start to talk to our clients on the other side,” within their traditional wealth management business, she said.
Danielle Walker is a freelance journalist with 15 years of business reporting experience. She previously worked at Business Insider and Pensions & Investments, among other business publications. Her work has been published in the Financial Times, Barron’s and Chief Investment Officer. Danielle is currently based in Norfolk, Virginia.
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The views presented here do not necessarily represent those of Advisor Perspectives.
