Due to the financial crisis that has occurred following the coronavirus pandemic, stock markets have been volatile and often down. As a result, private equity may be an option for 401(k) investments in the future. Private equity usually isn’t available for investments in 401(k) retirement accounts but because, in 2022, both stock and bond markets have been down, many investment professionals have been requesting that private equity alternatives be offered for 401(k) investments.

If you have questions about private equity funds and your investments, make sure to ask your financial advisor in Orlando.

What Is Private Equity?

Private equity refers to a type of investment fund that either buys companies. Private equity firms are partnerships of investors that buy up equity in companies and then either manage or restructure them prior to selling the company again for, ideally, a profit. These private equity firms also buy and sell private equity funds on behalf of other investors.

Do 401(k)s Include Private Equity Investments?

401(k) retirement accounts typically don’t include private equity funds among their investments. In defined-contribution plans, in particular, private equity funds usually aren’t an option. Private equity funds are more common in state or local defined plans, also known as pension plans, which have been increasing their private equity offerings in order to make up for a lack of funding. This lack of funding is a result of an aging population. Younger employees aren’t typically offered pensions and instead are usually offered 401(k) accounts by their employers.

What Is a Defined-Contribution Plan?

Most 401(k) retirement plans are defined-contribution plans. In this type of plan, both the employee and the employer contribute a defined amount into the account at an agreed-upon frequency, which typically matches that of the employee’s paycheck. According to a Cerulli Associates report that was issued in September of 2022, not even 1% of defined-contribution 401(k) retirement plans offered private equity funds as an investment option.

Why Do Investors Want Private Equity Options?

Many want to be able to invest in private equity funds because of a lack of retirement funding. More current retirees are able to rely solely on Social Security, but younger people don’t anticipate that it will be their primary source of income in retirement. Some believe that adding in private equity funds could help to make up a funding gap.

What Are the Risks of Investing in Private Equity Funds?

Private equity funds tend to be higher-performing funds, which can make them attractive to investors. At the same time, that high performance also means that they’re riskier than other types of investments. There are some other downsides to investing in private equity funds.

Private Equity Funds May Have Higher Fees

Private equity funds may be more expensive to purchase. This is because private investments may charge higher fees than public investment options like stocks do.

Private Equity Funds May Be Higher Risk

One of the attractions of private equity funds is that they have the potential to perform really well. Anything that has such potential, however, also carries greater risk. Investments with lower risk tend to stay more stable and don’t have as much potential for high returns. Risky investments can either swing very high or very low in terms of expected returns. Private equity funds are among these riskier investments.

Private Equity Is Illiquid

Liquid assets are those that are more easily converted into cash. Private equity fund investments are illiquid, which means that it can be difficult to sell them to get the cash balance.  It could take a lot more time to sell such funds, which could be a downside for people who have invested in them as part of their retirement funds. Once you have to start taking money out of your retirement fund rather than putting it in, illiquid assets like private equity funds may be less advantageous.

Smaller Company 401(k) Plans May Not Have Experience with Private Equity Funds

A recent trend with 401(k) plans has been for multiple companies to pool all of their plans together and have a single PEP plan provider. The idea behind this trend is to minimize employer involvement in the management of retirement plans. Such large plans would be managed by a company experienced in selecting quality private equity funds. Smaller plans wouldn’t necessarily have access to such expertise. This would mean that any private equity funds selected for investment might be riskier propositions.