For years, private equity and private credit were the exclusive playgrounds of institutional giants – think massive public pension plans, university endowments (like Harvard), and sophisticated investors. These “private market investments,” by their very nature, were off-limits to the average American saving for retirement in their 401k plans. But now, there’s a concerted push to open the doors of your 401k to these sophisticated asset classes.
This development sparks a critical question for every individual investor: Is this a golden opportunity for higher returns, or a risky invitation to a party you might regret? Much like the classic Western, when it comes to your retirement accounts, it’s time to discern The Good, The Bad, and The Ugly aspects of private equity and private credit making their way into your 401k.
The Good: The Allure of the Exclusive
Proponents argue that bringing private equity (PE) and private credit into 401k plans offers compelling advantages for portfolio diversification and potentially improved retirement outcomes:
Potentially Higher Returns (The “Illiquidity Premium”): Historically, private market investments have, at times, generated returns that outpace publicly traded stocks. This is often attributed to an “illiquidity premium” – the idea that investors are compensated with higher returns for locking up their capital for longer periods, as private assets are not easily bought or sold.
Diversification Beyond Public Markets: Private assets often exhibit a low correlation with traditional equities and bonds. This means they don’t always move in the same direction as traditional investments, potentially offering true portfolio diversification that could reduce overall portfolio volatility and enhance risk-adjusted returns.
Access to Unique Growth Opportunities: Private markets can provide access to innovative, fast-growing companies before they go public, or to specialized lending opportunities not available in traditional credit markets. This allows investors to participate in a broader investment universe.
Shrinking Public Market Universe: The number of publicly traded companies in the U.S. has declined dramatically over the last two decades. Many high-growth, innovative companies now choose to remain private longer, potentially leading to a lower “quality” or less diverse set of opportunities in public small-cap indices like the Russell 2000. Private equity can offer access to these companies.
For context: The number of publicly traded companies in the U.S. peaked around the mid-1990s, with figures often cited around 7,400 to over 8,000 firms in 1996.
By 2005, this number had already decreased to around 3,900 to 4,000 firms.
The decline continued, reaching around 3,400 to less than 4,000 firms by 2020. While more recent data for 2024/2025 shows around 4,700 to 6,000 U.S. firms (depending on the source and what is counted), the overall trend from the mid-90s to the 2020s is a substantial reduction.
Alignment with Long-Term Horizons: Retirement savings in a 401k are inherently long-term investments, often spanning decades. The multi-year lock-up periods typical of private investments are seen by some as a natural match for these long-term retirement savings goals.
Hidden Volatility Can Calm Nerves: Because there isn’t a public market with second-by-second pricing, smaller, day-to-day market moves are not immediately visible. For instance, if a private fund is priced on March 31st and then again on June 30th, you would completely miss the drama of any short-term market fluctuations that occurred in April. This less frequent valuation can reduce the perceived volatility, which for some investors can indeed calm nerves during turbulent times.
The Bad: The Hidden Costs and Complexities
Despite the enticing benefits, the characteristics of private equity and private credit introduce significant challenges and drawbacks for 401k plans:
Illiquidity: This is a major hurdle. Unlike publicly traded funds that offer daily liquidity, private investments typically have lock-up periods of 7-10 years or even longer. This means your money is tied up and not readily accessible. This directly clashes with a 401k participant’s potential need for liquidity for hardship withdrawals, rollovers when changing jobs, or systematic withdrawals during retirement’s decumulation phase, or in case of an unforeseen emergency, like Harvard’s current fight with the administration. According to some accounts, if Harvard has to sell these investments prematurely due to federal government funding cuts, it could take a 20% haircut or more.
Higher Fees: Private funds are notoriously expensive. They commonly charge a “2 and 20” fee structure (a 2% annual management fee on committed capital, plus 20% of any profits, known as “carried interest”). These high fees can significantly erode returns, meaning private investments must substantially outperform traditional public market funds just to break even after costs. For context, the average target-date fund in a 401k might charge 0.3% annually, while a private equity sleeve could add 2.5% or more.
Lack of Transparency & Valuation Challenges: Private companies are not subject to the same rigorous public reporting requirements as publicly traded companies. Valuations of private assets are often less frequent (e.g., quarterly) and can be subjective, making it difficult for the average investor to truly understand what their investment is worth at any given time. This opacity can obscure true performance and risk. As Tuco might say, “Every gun makes its own tune,” and in private markets, each valuation can indeed sing a different, less public, song.
Complexity: The structures and strategies of private funds are inherently complex, often involving leverage and intricate deal structures. This makes them difficult for typical 401k participants to understand, evaluate, and monitor effectively. It is already challenging to educate and engage the normal employee with their 401k, to the point where we have default target date funds and auto-enrollment. And this is with normal “simple” investments. Throw in complex illiquid investments, and engagement and investor education will be even tougher.
The Ugly: The Potential Pitfalls and Fiduciary Headaches
Beyond the inherent drawbacks, there are “ugly” scenarios and systemic concerns that arise when private investments enter 401ks:
The “Roach Motel” Effect for Participants: If a significant portion of a participant’s 401k is locked up in illiquid private assets, they could face a severe liquidity crisis. Imagine needing funds for an emergency, losing your job, or entering retirement, only to find a substantial part of your savings is trapped in an investment that cannot be easily sold or valued. This directly undermines the expected liquidity of a defined contribution plan and could negatively impact retirement outcomes.
Exacerbated Fee Erosion: While fees are “bad,” the “ugly” part is when these high fees, combined with potential underperformance (especially in an elevated interest rate environment where private equity has struggled to match public market returns recently), lead to significant wealth destruction for plan participants. The average 401k investor might not even realize how much their returns are being eaten away.
Increased Fiduciary Risk for Plan Sponsors: Employers (plan sponsors) have a fiduciary duty under ERISA to ensure that investment products are prudent and in the best interests of participants. Offering complex, illiquid, and high-fee private investments significantly increases the fiduciary burden and potential for litigation, especially if participants feel their retirement savings have been harmed. The Department of Labor’s cautious stance reflects this concern, and plan fiduciaries must exercise extreme due diligence in manager selection and ongoing monitoring.
Misalignment of Interests: Some critics argue that the push to include private assets in 401ks is driven more by the private equity industry’s desire to access a massive, untapped pool of capital ($12 trillion in 401ks) than by a clear benefit for the average worker. This can create a conflict of interest where the industry’s need for capital outweighs the individual investor’s need for suitable, transparent, and liquid retirement options. As Blondie might observe in a different context, “You see, in this world there’s two kinds of people, my friend: those who have money, and those who dig. You dig.” When it comes to liquidity, you don’t want to be the one digging for your retirement funds.
Never Been Kissed: Many of these alternative investments, like crypto, have never been tested in down markets. During times of stress, like 2009 or a few dark days in COVID. We have decades of wars and economic downturns that demonstrate the benefits of a diversified portfolio, such as the S&P 500. We don’t for Private Equity. What happens if markets and systems break? This uncertainty poses a significant risk mitigation challenge for plan fiduciaries and individual investors alike.
The Bottom Line: Stability and Predictability Over Speculation for Retirement
While the allure of private equity and private credit is undeniable, the fundamental characteristics of these investments – illiquidity, high fees, and a lack of transparency – pose significant challenges for the structure and purpose of a 401k.
For the vast majority of retirement savers, stability, liquidity, and transparency through well-diversified, low-cost public market investments (like broad-market index funds and ETFs) remain the most prudent and reliable path to building a secure retirement nest egg. The alluring might be tempting, but when it comes to your financial future, “stable” is usually the more desirable characteristic.
It’s worth noting that industry experts like Kevin Hanney have been vocal about the potential benefits and risks of including private market investments in 401k plans. Additionally, recent executive orders and guidance from the Department of Labor have aimed to clarify the regulatory landscape surrounding these investment options in employer-sponsored retirement plans.
As the debate continues, it’s crucial for both plan sponsors and individual investors to stay informed and prioritize prudent portfolio construction that aligns with their long-term retirement goals. While private equity and private credit may have a place in some sophisticated investors’ portfolios, their inclusion in 401k plans requires careful consideration of the unique needs and best interests of plan participants.
If you don’t have a plan and would like to get one, schedule an Intro Meeting:
This commentary is provided for general information purposes only, should not be construed as investment, tax, or legal advice, and does not constitute an attorney/client relationship. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable, but is not guaranteed.
This commentary is provided for general information purposes only, should not be construed as investment, tax, or legal advice, and does not constitute an attorney/client relationship. Past performance of any market results is no assurance of future performance. The information contained herein has been obtained from sources deemed reliable, but is not guaranteed.
