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Written by: Thomas Kostigen
A new change in regulatory guidance allows people to invest their 401k capital in investments long favored by billionaires. But investors ought to use caution before making the plunge into this, or any new asset class with which they have little or no experience.
On June 3rd, the Department of labor, which oversees the fiduciary responsibility of how 401k plans are managed, said it was okay with defined contribution retirement accounts having a private equity option. That is a huge departure from the conservative stance the oversight agency typically takes with employees’ savings.
Private equity is stock in private companies that are not listed on publicly traded securities exchanges. And the ruling was careful to note that it was only approving participant investments in private equity fund vehicles, not individual company stock.
Private companies welcome the news. The American Investment Council, an association for the private equity industry, said “expanding access to private equity will strengthen retirement security for millions of Americans.” The position is the more investment options for 401k participants, the better.
Forbes magazine, however, had a different point of view: “Trump DOL throws 401k investors to the wolves,” screamed its headline. “Trump U. S. Department of Labor watchdogs just opened the door for private equity wolves to sell the highest cost, highest risk, most secretive investments ever devised by Wall Street to 401k plan sponsors. 401k investors will be devoured like lambs to the slaughter,” it wrote.
The concern is that private equity investments are inherently risky and illiquid.
Moreover, private equity fund managers are legend for charging high fees and reaping huge management income from the funds they manage. The allowance came after some investors questioned why institutional pension funds, or defined benefit plans, could invest in higher returning private equity funds and 401k plans, or defined contribution plans, could not.
All being even, should Main Street investors take the plunge into areas reserved for so-called sophisticated investors? Maybe. Sophisticated investors, as defined by the Securities and Exchange Commission, are people with $200,000 in annual income, a net worth exceeding $1 million (excluding the value of a home), or joint annual income with a spouse of more than $300,000.
For years the SEC has allowed this group of investors to take more risk with their investments and investment in less regulated securities, such as private equity.
The idea behind the high net worth bar is seemingly to protect average investors. Many believe, however, that it’s exclusionary. After all, just because you are rich does not mean that you are better suited or more knowledgeable about investments. Getting in on, say, Google, while it was a private company, would have been a far better investment than investing in it after it went public.
The challenge with private investment is that they are often illiquid, meaning you can’t easily sell your position. The DOL apparently believes the more investments and the more investors, the more likely to find a buyer to find a seller and vice versa. By opening the floodgates to more investors — 401ks are how the majority of American invest in the capital markets and accounts for trillions of dollars— more liquidity certainly can be brought to the market, in theory anyway. That’s a bet.
Private companies also follow different rules than publicly traded corporations. They have to adhere to far less regulatory scrutiny and disclose far less to investors. So sure, it may be cool to say that you can now invest the same way as Bill Gates, or Jeff Bezos, who frequently invest in private equity, but whether you should be investing in this asset class is an entirely different proposition. To answer that, a financial professional should be turned to for advice. The decision shouldn’t be made in private.