The Retired Investor: Investing in Tax-Deferred Accounts

Risks and rewards in adding new investments to your tax-deferred investment accounts

 

An executive order instructing the U.S. Labor Department to consider the pros and cons of adding several new investment choices to your tax-deferred investment accounts is underway. A decision on the president's order won't happen overnight. 

 

Last week, I covered the benefits of adding private equity, real estate, and digital assets to the existing mix of stocks and bonds in retirement accounts. Backers of this initiative cheer the president's executive order and say it will expand the investment opportunities for retirees. It also offers much more diversification than simply stocks or bonds. Why, they say, should investors lose out on the spectacular returns that private investments, real estate, and cryptocurrencies offer? Anyone who has looked at the performance of Bitcoin or Ethereum this year might agree.

 

Technically, private market investments are already allowed in 401(k) plans. In addition, there are also ways to invest in crypto, and there is now a long list of exchange-traded funds offering investments in the digital currency space. Why, therefore, haven't those employers that provide tax-deferred accounts embraced these assets? The short answer is risk.

 

The risks in some of these investments are much higher than in your ordinary stock or mutual fund. In some cases, if you are in the wrong asset, savers can lose a hug chink of their retirement savings. In the private markets, for example, there is a lot less transparency and liquidity. Information can be scarce in analyzing a private company, and if there are periods of financial panic, markets to offload your investments can dry up or disappear entirely.

 

Management fees are also much higher than in the public equity markets, sometimes as much as two or three times the typical fee on a mutual fund holding stocks and bonds. Employers who would offer these assets could be held liable for losses. The issue for many savers is a potential lack of restraint in investing in risky assets. Without proper guardrails, such as limiting exposure to 5-10 percent of the portfolio, investors could be exposed to unnecessary risk and significant losses unless they were protected by some conditions set forth by the Labor Department, for example. 

 

We all know the history of cryptocurrencies. Digital assets have had several periods of deep declines. Prices have more than halved at times and then gained little over several years before once again climbing. Just last week, some of the most popular cryptocurrencies, Bitcoin and Ethereum, saw wild swings in their prices, both up and down. There have also been digital hacks of account holders' assets, fraud, and some crypto kings are languishing in prison to this day.

 

Both the Labor Department and the Securities and Exchange Commission have roles to play in allowing access to these alternative investments. The Labor Department, which governs tax-deferred retirement accounts, needs to establish rules and regulations, a so-called safe harbor, for plan fiduciaries that would protect them from lawsuits. Plan sponsors, in turn, would need to select investment options designed to protect retirees, like limiting the amount savers could accumulate, ensuring these investments provided the required liquidity, and determining if the fees charged were in line with the returns of these assets.

 

The SEC's role would be to ensure the expansion of registered closed-end funds managed by registered investment advisors that invest in private equity and private credit funds. These funds need to be registered and listed on exchanges, providing the liquidity necessary to ensure functioning markets in downturns.

 

Even if Labor and the SEC were to green-light these added investments, the rules and regulations would require months to write, and that may be an optimistic appraisal. Neither of these government bodies is noted for its ability to make swift decisions about anything. In which case, by the time they get around to deciding on this initiative and enacting it, we may have a new president in office.

 

Bill Schmick is the founding partner of Onota Partners, Inc., in the Berkshires. His forecasts and opinions are purely his own and do not necessarily represent the views of Onota Partners Inc. (OPI). None of his commentary is or should be considered investment advice. Direct your inquiries to Bill at 1-413-347-2401 or email him at bill@schmicksretiredinvestor.com.