Big changes might soon be in store for retirement investors.
The Trump administration has issued an executive order loosening regulations around company-sponsored retirement plans, which means Americans invested in a 401(k) or other workplace plan might soon be able to diversify into alternative investments such as private equity, private credit and real estate.
Is this good for the average investor? While there’s still a lot to learn, the general idea of opening alternative assets to a wider investor base outside of accredited investors is certainly positive.
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In the past 30 years, the number of public companies has fallen dramatically, from a peak of about 7,000 in 1996 to roughly 4,000 in recent years.
This shrinking public market universe means investors today are more concentrated than ever, with many index funds dominated by a handful of megacap Magnificent 7 stocks.
A path to wider diversification
That’s why expanding access to private equity, credit and real estate funds could provide valuable diversification.
There are pros and cons to diversifying into alternative investments. If the Department of Labor and SEC, which are ultimately responsible for carrying out the executive order, give the green light to allow the rule change, employees who want to invest in alternatives through their workplace retirement plans should speak with an experienced financial adviser about the following:
Investment vehicles. The world of alternative investments is wide and deep, encompassing everything from private equity and credit to commodities, venture capital and real estate investment trusts (REITs), among others.
While there’s still a lot we don’t know, one thing is certain: Employees won’t be able to use their retirement savings to invest in a one-off real estate project or a single private-equity deal.
Instead, large fund managers will likely package alternatives into diversified vehicles, similar to mutual funds, helping reduce single-deal risk. It’s important to understand all the aspects related to the investment — liquidity, fees, etc. — to ensure it’s right for you.
Age-related considerations. Unlike public markets, alternative investments have longer lock-up periods, which helps provide a buffer to short-term market volatility.
Most employee-sponsored retirement plans use target-date funds to place individuals in age-appropriate vehicles, and my guess is that they’ll follow the same formula for alternatives, with the percentage of alternative investments getting smaller as the investor ages.
If that’s the case, individuals won’t have to think too hard about the ratio of stocks to bonds and alternatives, as it’ll be baked into the formula.
Even so, it’s a good idea to speak about the options with someone who has experience in alternative investments, as human resources departments often fail to serve as an effective conduit between a fund administrator and employee.
Fee structure. While alternative investments offer access to untapped markets that can help diversify portfolios, they traditionally come with higher fees.
Are the higher fees offset by the potentially outsized returns? A financial adviser can help you determine if the pluses of alternatives — namely, diversification and higher returns — outweigh the heftier fees.
A logical next step
While the financial services industry is abuzz about potentially allowing alternatives into company-sponsored retirement plans, the rule change isn’t particularly novel or radical.
IRA holders and investors in solo 401(k)s can already access these types of opportunities, so any change will broaden these options to a larger investor pool.
Allowing alternatives into company-sponsored retirement accounts is a logical next step. Retirement plans have longer time horizons, which make them ideal vehicles for illiquid assets such as private equity and real estate.
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These vehicles also provide access to opportunities that were once limited to institutions and ultra-wealthy families.
Ultimately, investors considering diversifying into alternatives should consult with an experienced and knowledgeable financial adviser who can help them fully understand their options and whether it makes sense to allocate through a retirement account or a self-directed option.
It will also be critical to formulate how much exposure makes sense for each individual’s financial goals and timeline.
Except where otherwise indicated, the information contained in this article is based on matters as they exist as of the date of preparation of such material and not as of the date of distribution or any future date. It does not constitute advice or a recommendation or offer to sell or a solicitation to deal in any security or financial product. It is provided for information purposes only and on the understanding that the recipient has sufficient knowledge and experience to be able to understand and make their own evaluation of the proposals and services described herein, any risks associated therewith and any related legal, tax, accounting or other material considerations. Recipients should not rely on this material in making any future investment decision. To the extent that the reader has any questions regarding the applicability of any specific issue discussed above to their specific portfolio or situation, prospective investors are encouraged to consult with the professional adviser of their choosing.
