Private Equity in Your 401(k) Portfolio? It’s a Bad Idea

Posted: Jun 29, 2020 9:00:00 AM

Private Equity imageAs a 3(38) investment fiduciary who speaks with employees and gauges their understanding of their account holdings, it is safe to say that this country has a huge financial illiteracy problem. When I am told not to use the word “equity” and instead use the word “stock”, because people do not understand what I am referring to, that gives me pause. It is for this very reason that Granite Group Advisors created an investment education website for financial advisors and their retirement plan clients so they could gain clarity on their risk and needs.


The lack of financial literacy is the crux of my issue with the U.S. Department of Labor’s decision opening the door for plan sponsors to add private equity funds to their 401(k) plans. Simply put, it’s a bad idea. And this is the opinion of someone who is a former employee of Donaldson, Lufkin & Jenrette (DLJ), once a bastion of private equity investing. Here are just a couple reasons why it’s best to think more than twice about this alternative investment:


  1. It’s really complex and if the average employee does not understand the risks they take within their own portfolio now, adding private equity is a recipe for disaster.
  2. Private Equity is illiquid. If someone is three to five years away from retiring, should they invest? The average gestation period is five to seven years before any liquidity usually happens.
  3. For employees without investment knowledge it’s a bit like gambling. They would be lured by the potential for outsized returns but those returns also come with the risk of outsized losses.


If the DOL is silly enough to allow such a high-risk investment sector into a retirement account, there would need to be a variety safeguards installed on record-keeping systems to ferret out bad actors and protect investors. It would be operationally difficult to do this. ERISA litigator attorneys would have a field day. Also, the employer (plan fiduciary), will have to approve a record-keeper and by default will likely rely on the qualification system that allows an employee to participate. I would not want to be the plan fiduciary, or the record-keeper charged with validating the process to protect employees. The amount of investment education to be imparted would be daunting for the majority of advisors. As a 3(38) investment fiduciary, who personally and actively invests in private equity, I would require indemnification from the employer and from plan vendors if private equity was a part of the fund lineup.


If 40 Act pooled investment funds for liquid alternative assets, Exchange Traded Funds or some other structure are created for private equity, let 401(k) investors invest on their own and not through a retirement plan. The upside could be great, but the downside would be devastating.


For plan sponsors who decide to dip their toes into private equity, my best advice is to ensure your 3(38) is well versed and qualified in these types of investments. Based on your specific plan, your 3(38) needs to be a partner in protecting and managing your plan to align the risks with financial goals for the short and long term.


Have questions on alternative investments and other fund selections? Contact us at (203) 210-7814. We have answers and are committed to your best interests in providing full transparency while optimizing your 401(k) plan.