Opinion | Trump Wants to Liberate 401(k)s

The Trump Administration last week proposed a legal safe harbor for employers that want to diversify 401(k) investments beyond stocks and bonds. Cue Democrats and trial lawyers flogging troubles in private credit to warn the proposal will endanger retirement savings. According to this narrative, the Labor Department is blowing open 401(k)s to risky investments that could include Trump meme coins. Sorry, not true. The Labor Department is proposing to clarify that employers don't violate their fiduciary duty merely by incorporating private equity, real estate and other "alternative" investments in 401(k) fund options. The 1974 Employee Retirement Income Security Act requires employers that sponsor retirement plans to manage investments prudently and solely in their beneficiaries' interest. Congress's intention was to prevent self-dealing. But plaintiff lawyers have sued companies if they offer 401(k) options other than plain vanilla funds comprised of stocks and bonds. Private equity and credit markets have swelled in recent decades while the number of public companies has shrunk by more than half. More companies are staying private, or waiting longer to go public, because of laws like Sarbanes-Oxley and regulation. As a result, workers may be missing higher returns from a more diverse portfolio that includes private investments. The top 10 companies in the S&P 500 make up 40% of the index's market capitalization. 401(k)s invested only in stocks means millions of Americans have their retirements dependent on a relatively narrow group of firms like Nvidia and Tesla. Meanwhile, government pension funds have been investing more in private equity and alternative assets, which make up a third of their portfolios on average. Ditto university endowments. Harvard credits its strong endowment returns to such investments, which are 77% of its portfolio; only 14% is in public equities. Enter the Trump DOL, which wants to liberate employers to offer private equity and other alternatives in blended 401(k) funds. Doing so isn't without risk. PE firms and other such assets can come with higher fees than passive funds. Investments are also less liquid, and price discovery can be spotty. The salient question for fiduciaries is whether the investments are likely to produce a higher net return over the long term after fees. The answer may differ based on a fund's management and asset selection. But it's notable that private equity overall returned 15.1% annually on average between 1984 and 2024, versus 11.7% for the S&P 500. As for liquidity, the risks may be overstated. While workers can roll over 401(k)s when they leave jobs, few seek to liquidate them before they retire owing to high withdrawal penalties. The proposed rule would require providers to review and manage liquidity risks, which may mean capping alternative investments at a modest share of the portfolio. Procuring accurate and timely valuations for private investments may prove more difficult. Private fund managers have proposed using third-party auditors to value investments in 401(k)s on a monthly basis. But conflicts will still have to be carefully managed -- i.e., funds shouldn't tie auditor pay to their valuations. There's a risk that even auditors will fail to accurately assess a fund's value or are late to appraise changes. To qualify for DOL's safe harbor, fiduciaries will have to consider an alternative investment's performance, fees, liquidity, valuation and complexity. Employers won't qualify if they pile a worker's savings into crypto or funds that charge high fees for low risk-adjusted returns. As for recent private credit worries, AI has spurred an investor flight from some funds with heavy exposure to software businesses. Alleged fraud by subprime auto lender Tricolor and parts supplier First Brands, both of which failed last year, has also raised concerns about underwriting in private markets. These risks bear watching as ever. But public market investments aren't necessarily less vulnerable to market gyrations or fraud than private companies. Shares in public companies can fall abruptly. Trevor Milton, founder of the electric truck manufacturer Nikola, was convicted of misleading investors in 2022, presaging Nikola's bankruptcy last year. Retail investors already have access to alternative investments through closed-end business development companies and real estate investment trusts (REITs). Workers would be better off having Vanguard or Fidelity manage their exposure to such investments than investing in them based on tips from Reddit. Employers don't have to offer private investment options. But why shouldn't they be able to offer workers the choice?