What is Private Equity and What Could it Mean for Your 401k?

June 24, 2020
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Earlier this month, the U.S. Department of Labor released a letter that stated private equity investments would soon be allowed within certain retirement plans. There will be specific rules to follow and more details to learn, but we could start seeing some 401k plans include private equity offerings. These investments are usually only reserved for the super wealthy, so it could be significant for for many people on standard retirement plans. There are pros and cons that need to be weighed.

Understanding Private Equity

First, let’s clarify what private equity is, in case you are not already aware. Private equity is investing in shares that are outside of the public stock exchange. It can include buying into a specific company, raising seed money for a start-up or contributing to a capital funding organization that buys and restructures companies. The most common types of private equity investments include:

  • Venture Capital
  • Growth Capital
  • Leveraged Buyouts
  • Distressed Investments
  • Mezzanine Capital

Because of their fees and funding systems, private equity firms are generally very profitable regardless of how the companies they invest in perform. That’s what makes this new concept enticing for many. At the same time, it is not without its risks. There are reasons why private equity has not been a part of traditional 401ks until now.

Potentially Higher Returns

Some experts will say that 401k savers can use private equity funds to get stronger returns on their investments. That’s the obvious appeal, along with the long-term nature of many private equity funds that take time to be distributed and mature into significant profits. The guidance from the Department of Labor also provides more legal protection to businesses that offer private equity as part of their 401k plans.

New Risks to Consider

Under the guidance, 401k plans will not be allowed to invest solely in private equity. This is to protect the individual planholders. Other financial experts believe that private equity investments will expose people to higher service fees and increased risk compared to typical 401k investments that are usually designed to be conservative and “safe” over time. Then, there are always fears of more predatory practices from private equity firms. More guidances may come with a goal to make private equity a legitimate part of certain 401k plans while mitigating investor risk as much as possible.

The biggest question is if private equity is really necessary for the average individual with a 401k plan through their employer. There are still many questions to ask and rules to implement, but it is definitely an interesting topic and one I will be keeping a close eye on as some 401k providers begin exploring private equity options.

Making Smart Financial Decisions

As with any new financial concept, there are potentially big opportunities while there are plenty of risks at the same time. Only time will tell, and there will always be “experts” endorsing one side or the other. It’s important to do your own research and speak with your financial advisor before jumping head-first into a new 401k plan. Look at all your options and make the best decisions.

Illumination Wealth works with both individuals looking to maximize their retirement savings and business owners exploring the best 401k plans. Let us help you make the right decisions and get the most out of your money. Contact us today to schedule an introductory financial consultation.