The Feeding Frenzy Around Your 401(k)

Dear subscriber,

As individuals, we are poor. As a group, we are extremely wealthy.

You always hear statistics about how little the average American has saved for retirement.

The median U.S. household has less than $87,000 in retirement savings. And that's not good.

But for most people, their main retirement asset is their 401(k). And collectively, Americans have $12 trillion in their 401(k) accounts. (For comparison, the entire U.S. stock market stands at about $60 trillion.)

Wall Street and other financiers have been eyeballing that cash pile for decades. And they're making a big move to try and add it to their assets under management.

The promise (from Wall Street) is that being able to manage Americans' retirement accounts will lead to higher returns over the long term.

Of course, the question every investor is asking is... what does this mean for my retirement plan?

Let me tell you...

On August 7, President Donald Trump signed an executive order directing the Department of Labor to revisit the rules on alternative investments in retirement plans like 401(k)s and 403(b)s.

Many outlets are now reporting that the government is "opening up 401(k)s to private equity and crypto."

That's not exactly right. This is a long and complicated process. The regulations around retirement accounts are draconian and often ridiculous.

But I can explain it in a few lines – and if you've got a 401(k), you should know how it works.

If you have a 401(k) with your employer, your "menu" of investment choices is governed by a "trustee." (This could be your employer or an outside individual.)

The trustee has a fiduciary duty to do what is in the best interests of the individual investors. That includes not letting them purchase bad investments. If they don't act in the best interests of the individual... big legal trouble.

Specifically, trustees need to select investments "prudently." And over the decades, they've been very prudent indeed.

Trustees take very little risk on what investments they allow.

For a long time, plans only offered a small handful of very basic mutual funds. In recent years, that has opened up to an average of around 20 funds.

But it's still a small and conservative list. No one wants to get sued because retirees lost money.

Now, Trump has ordered that the secretary of labor review the rules and regulations under the Employee Retirement Income Security Act ("ERISA") – which regulates retirement and health plans – and provide more guidance. It's expected that this reexamination will relieve some of the pressure on trustees and open up more investment options.

Is this a good thing? Well, there are two sides to that question...

In general, more options are better. I've never liked the idea of government regulators restricting the investment choices of independent adults.

At the same time, your 401(k) comes with a high degree of financial danger... and almost no one knows what they're doing.

It's not that hard to learn to invest your 401(k) with some basic knowledge. But most people have busy lives and don't have the time or inclination to figure it out.

According to a 2023 CNBC Your Money survey, 46% of 401(k) investors have no idea what investments are in their workplace retirement plan.

The way I see it, investment choices are like power tools. They should be sold freely at the hardware store. But you need some training if you're going to do something like build your own deck.

A wider array of investment options, in general, would be great for some folks... and confusing and dangerous for others.

For instance, when it comes to cryptocurrencies and private equity ("PE"), I'd warn 401(k) investors to steer clear.

These Risky Investments Aren't for Your Retirement Savings

Crypto gets the gentler warning, so let's start there...

As incredible as crypto returns have been during certain periods, this is the exact kind of thing that draws novice investors in and wipes them out.

I love crypto. I own it. I've mined it. It's becoming more accepted as a store of value and a part of mainstream finance. And I believe you should own some.

But it can absolutely go to zero. So when it comes to your retirement savings, tread very carefully here. Don't get carried away with the crypto hype.

There are investors out there that will put 20%, 50%, or even 100% of their retirement funds into crypto, and that is insane.

You shouldn't even have 100% of your retirement account in stocks. Never mind something as speculative as crypto. You need a collection of assets to balance your risk.

At most, crypto should be 5% – maybe 10% – of someone's account if (and only if) they're an informed and experienced crypto bull.

Private equity is another matter...

Wall Street has initiated this push to open up 401(k)s. They want to manage as much of that $12 trillion as they can.

Private equity, as a whole, has something like $5 trillion in assets under management. So this is a big opportunity.

The PE industry says that it provides higher returns with less risk than public stocks. It also says that the long-term time frame of retirement investors perfectly suits PE's long holding periods.

How nice of them to help everyday investors earn higher returns!

Of course, the truth is that the PE crowd wants to manage your money so they can collect more in fees.

And all of those proof points they have... they're a little shaky.

For example, private equity claims higher returns. But the measure they use – internal rate of return ("IRR") – is different from the one the stock market uses. Moreover, IRR relies on the timing of cash flows. And academics and skeptics have questioned whether that's a fair measure, as cash flows are controlled by the PE fund, which tends to inflate returns.

That said, as the PE industry has grown larger, it has attracted more capital and competition... and its returns have eroded. So PE's impressive historical returns may not continue in the future.

Private equity also claims lower risks due to things like less volatility. But that's because their investments don't trade in public markets, so they often get to make up their own prices. Then, they point out that prices aren't volatile... but that's nonsense.

The value of the investments they hold, in reality, fluctuates just like those of the stock market. You just can't see it in a quoted price. (Quantitative hedge-fund billionaire Cliff Asness calls this "volatility laundering.")

Lastly, private equity does make long-term investments... but they're also illiquid. They can't buy and sell them quickly. They hold them for years and only occasionally make big "exits" when they can sell an entire company.

And no one knows yet how private equity can take these illiquid investments and put them into funds that individual investors can put in their 401(k)s.

Wall Street will figure it out. I'm sure of that. But I also know it will take a lot of financial engineering. And the end result will be complex... in a business where simplicity is best.

Overall, you can't know whether PE in your 401(k) makes sense until we see the product it's packaged in. I'm skeptical already, as PE investments will come with significantly higher fees than index funds.

Again, private equity thrives on fees. The typical PE fund manager charges 2% of assets and 20% of returns, like a hedge-fund manager. They also charge management fees that come out of the profits of the companies they own.

And you can bet they're not going to cut a deal for mom-and-pop investors.

While private equity in your 401(k) sounds intriguing, it's not happening out of the goodness of Wall Street's (or the government's) heart.

It's happening because they want to generate monster fees on trillions of retirement dollars.

In short, when it comes to your retirement... keep it simple. Keep your fees low. And tread carefully whenever Wall Street wants to offer you a great new investment. It has always thought about its own angle first.