As retirement plan menus evolve beyond traditional stocks and index funds, everyday savers are encountering a wider range of alternative investments. Former NBC “Today” show finance editor Jean Chatzky warns that while expanded 401(k) options sound attractive, they won’t automatically lead to better retirement savings results.
The most notable addition to the defined-contribution space is private equity—an investment strategy that pools capital to buy, restructure, or directly invest in private companies that do not trade on public stock exchanges.
While alternative assets have historically been reserved for high-net-worth individuals and institutional giving, Chatsky warned that high management fees, tight liquidity constraints and long lock-in periods could be detrimental to the typical worker who relies on steady compounding for retirement.
“Wall Street will always innovate,” Chatsky wrote on HerMoney. “When it sees an opportunity to expand access to products — especially products that have traditionally been limited to high-net-worth investors — it will do so. But more choice does not automatically mean better outcomes.”
“Low-cost diversified index funds remain a strong and proven foundation for many investors,” she continued. “For others, a small allocation to alternatives may make sense, but only as part of a well-thought-out plan.”
Chatzky highlights private equity fees in 401(k)
Chatsky said that the private equity industry has traditionally adopted a “2 plus 20” structure, charging a 2% management fee and taking 20% of investment income.
“If you can buy private equity as an individual investor, it’s worth far more than your average index fund ETF, which has fallen to a fraction of a percent in price,” Chatsky wrote.
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Chatzky asked Liz Miller, CFP, CFA and former chair of the CFP Board of Directors, about private equity fees.
“These structures have always been very expensive. I’ve always felt that the returns on these structures tend to get lower and lower over time,” she said.
Miller added: “Investors in these funds are happy with this because over time they are getting returns that are much higher than the returns in the public markets.”
“Like any product, as we develop it and capture a larger and larger share of the market, I’m not sure we’ll see those kinds of returns.”
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Another consideration: Traditional vs. Roth 401(k)s
In addition to private equity in 401(k) accounts, there is another consideration I want to consider before returning to some issues with private equity in retirement plans.
Over the years of reporting on personal finance and retirement savings, I’ve seen evidence time and time again that it’s important for investors, regardless of their 401(k) plan, to take a step back and consider the tax implications and which options are best for each individual.
Specifically, a very important decision here is whether workers should invest in a traditional 401(k) plan or a Roth option.
Fidelity Investments provides a clear explanation for this difference.
Fidelity writes: “In a traditional account, your contributions are typically pre-tax (a 401(k)). The opposite is true with a Roth account: Contributions are made with money that has already been taxed (your contributions do not reduce your taxable income), and when you withdraw the money in retirement, there are generally no taxes on it.”
“This means you need to choose between paying taxes now or paying taxes in retirement,” Fidelity explains. He suggests people need to decide whether they think current taxes are lower than future taxes, or vice versa.
Reviewed Prop Firms CPA Dat Ngo has a different view on the decision.
“One of the things I always present to clients is that the Roth versus traditional decision is not just about your expected tax rate, it’s about your current income trajectory,” Ngo told me. “If you’re in a lower tax bracket now and expect meaningful income growth over the next decade, paying your taxes up front through a Roth contribution is often the smarter long-term move.”
“That said, for people who are already in a higher bracket and expect to have lower incomes in retirement, the traditional IRA deduction can provide real, immediate relief,” he added. “There is no universal right answer, which is why people should calculate the numbers based on their own circumstances rather than default to rules of thumb.”
Ngo is a CPA and personal finance expert who draws on his experience and expertise, with a focus on tax planning.
Chatzky asks 5 questions about private equity in 401(k)s
Chatsky said there are five main questions investors should ask themselves before adding private equity to their portfolio.
- Do I fully understand how this investment works?
- How will these fees affect my long-term compound interest?
- What am I giving up in terms of liquidity?
- Does this fit with my time horizon and retirement income plan?
- Do I invest because it fits my strategy, or because it sounds complicated?
- (source: her money)
Regarding private equity in 401(k) plans, Chatzky emphasized a key point.
“The most important conclusion is not whether private equity is ‘good’ or ‘bad,'” she wrote. “You never feel pressured to adopt a new investment just because it’s marketed more broadly.”
This article is for informational purposes only and should not be construed as personalized tax or investment advice.
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