Ric Lager, president of Lager & Company, which advises 401(k) plan participants, Golden Valley, Minnesota. He is author of Forget the Pie: Recipe for a Healthier 401(k). LagerCo.com
You might be tempted by an opportunity to invest in young, fast-growing companies long before they go public. Earlier this year, the Labor Department approved the inclusion of such “private equity” investments in 401(k) and retirement plans. Investors can invest in them indirectly through target-date, balanced or similar funds offered by the plans, and no more than 15% of total assets held by any of those funds can be in private equity. Over the past decade through the first quarter of 2020, US private-equity funds averaged a 13.1% annual return after fees versus 10.5% for the S&P 500 Index, according to Cambridge Associates. And the super-performing stocks Facebook, Netflix and Tesla all were funded in part with private-equity money before they issued stock to the public.
As tempting as private equity might seem, most small investors should steer clear. Here’s why…
Uncertain performance figures. Unlike stocks traded on a major exchange, there is no simple way to determine the value of an investment in a private company until the company goes public or is sold.
Money lock-ups. Private-equity funds often have strict limitations on when investors can cash out shares. Lock-up periods typically last five years or more.
Exorbitant expenses. Private-equity funds typically take 20% of any profits each year in addition to a 2% annual expense ratio, which can hurt the performance of a target-date or balanced fund holding private equity.
What to do: If you are investing in a target-date or balanced fund, ask your plan sponsor whether the fund has exposure to private equity, which could significantly increase volatility and uncertainty about the fund’s performance. Consider shifting to a fund that does not invest in private equity or a more conservative target-date fund, such as one with an earlier target date.