New legislation has expanded access to alternative investments in retirement accounts. Here’s what you should know.
Alternative investments like private equity, private credit, hedge funds and real estate can be valuable tools for investors seeking specific goals with their portfolios. Long seen as the purview of institutional investors, alternative investment strategies have become more accessible in recent years with lower minimum investments and greater support from wealth management platforms. Adding to this shift, new rules have created pathways for tax-advantaged retirement plans to incorporate alternative investments alongside their traditional offerings.
Alternative investments, especially as part of a retirement strategy, might not be the right fit for every investor. While they can offer attractive opportunities for growth and diversification, they also come with unique risks and complexities. Incorporating alternative investments into your retirement strategy should be considered carefully and with your broader financial goals in mind.
Pension plans have used alternative investments alongside stocks and bonds to provide secure retirement to essential workers, like teachers, police officers, firefighters and nurses. But traditional pensions account for a shrinking share of retirement plans these days.
Most Americans now save for retirement through defined contribution plans like 401(k)s. But investment selection in most 401(k)s has been limited to publicly traded stocks and bonds. This difference in the money managers’ preferences has created a gap between investors with pensions and individual retirement savers.
This shift is happening at the same time private markets have grown significantly. Over the past few decades, companies have skewed toward staying private longer, and economic activity outside of the public market has increased.
Expanding 401(k) access to private markets may help diversify portfolios and improve long-term outcomes. The potential benefit comes from diversifying a portfolio with assets that navigate market cycles away from public markets to help reduce volatility. For example, if the public market experienced a broad decline – during a recession or market shock, for example – certain alternative or private market strategies may be insulated from the public market fluctuation.
Advocates argue that you can create a stronger, more resilient portfolio by mixing traditional and alternative asset classes that behave differently, just as one may mix stocks and bonds. If one segment lags, others can offset the shortfall, producing a more stable long-term result.
But they should be implemented with care. Some concerns are the potential for higher fees, lack of transparency and the complexity of manager selection. Another inherent risk of private markets is their limited liquidity. When it comes to retirement funds, this requires careful planning because distributions may become mandatory.
Thoughtful plan design and how these alternative investments are incorporated into the options is key. Professionally managed vehicles, multi-manager funds and target-date structures may be able to mitigate the risks associated with the complexity of alternative investments.
In adding alternative investments to defined contribution plans, such as 401(k)s, there is inherent oversight. Plan sponsors and investment managers are required to act in the best interests of participants and follow established fiduciary standards when selecting and monitoring investments. And this will be no different in the case of alternative investments.
Whether private equity should be part of your retirement strategy depends on a variety of factors, including your risk tolerance, investment time horizon and overall financial situation. Investors with a longer time horizon may decide to weather market fluctuations and allow investments time to mature, while those nearing retirement may want to place a greater emphasis on liquidity and capital preservation. This is an asset allocation consideration.
Retirement strategies aren’t a one-size-fits-all solution, and that includes the place private equity investments have in your 401(k). This should be a conversation like every other aspect of your financial plan.
Sources: MFA; Wharton
Alternative investments involve specific risks that may be greater than those associated with traditional investments and may be offered only to clients who meet specific suitability requirements, including minimum net worth tests. You should consider the special risks with alternative investments including limited liquidity, tax considerations, incentive fee structures, potentially speculative investment strategies, and different regulatory and reporting requirements. You should only invest in hedge funds, managed futures or other similar strategies if you do not require a liquid investment and can bear the risk of substantial losses. There can be no assurance that any investment will meet its performance objectives or that substantial losses will be avoided. Diversification does not guarantee a profit nor protect against loss.
