Private Equity in 401(k)s: A Risky Gamble with Retirement Savings

The debate over whether to include private equity in 401(k) retirement plans has intensified as regulators consider easing restrictions. Proponents argue that private equity's long-term growth potential can boost retirement nest eggs. But beneath this optimistic narrative lies a reality fraught with liquidity risks, transparency gaps, and escalating fiduciary liabilities—all exacerbated by private equity's current struggles to exit assets and declining returns. For retail investors, the stakes are too high to ignore these warnings.

The Liquidity Trap: A Backlog of Illiquid Assets

Private equity's exit challenges have reached a critical juncture. As of 2024, 61% of buyout-backed assets have been held for over four years, with average holding periods rising to 6.7 years—far beyond the historical average of 5.7 years. This backlog reflects sponsors' difficulty in selling assets at favorable valuations, particularly given elevated entry multiples from the 2021–2022 boom.

The secondary market, often cited as a liquidity solution, is no panacea. Investors in secondary transactions accepted an 11% discount (receiving 89% of net asset value) in 2024, up from 85% in 2023. This reflects lingering skepticism about future performance, as sponsors increasingly turn to sponsor-to-sponsor sales to offload assets—a strategy that risks transferring overvalued stakes to retail investors.

Transparency Gaps and Hidden Costs

Private equity's lack of transparency poses a direct threat to retail investors. Unlike publicly traded securities, private equity funds operate with minimal disclosure, making it nearly impossible for 401(k) participants to assess risks or valuations. Morningstar's analysis of large pension funds reveals a stark reality: even institutional investors struggle to achieve consistent returns. Oregon's Public Employees Retirement Fund (OPERF), for instance, saw its private equity portfolio underperform its benchmark by 32 percentage points in 2024, with an IRR of 7.2% versus a Russell 3000-based benchmark of 39.2%.

Worse still, fees compound the problem. Pension funds pay 1.5–2% in management fees plus performance fees, yet returns have failed to justify these costs. For 401(k) participants, who lack the scale to negotiate better terms, these expenses would erode already modest retirement savings.

Fiduciary Liabilities: Who Bears the Risk?

The fiduciary duty of plan sponsors to act in participants' best interests is under scrutiny. Allowing private equity in 401(k)s could expose sponsors to lawsuits if returns underwhelm—a risk amplified by recent underperformance. Morningstar's research highlights that even large pension funds, with dedicated teams and resources, have not consistently outperformed public market benchmarks. For retail plans, which lack such expertise, the liability burden grows exponentially.

Consider the MissionSquare Diversifying Strategies Fund, which achieved a 5.63% three-year return as of mid-2024—marginally better than its benchmark but over a short period. This narrow margin of success, coupled with the fund's complexity, underscores the precariousness of such investments for unsophisticated investors.

Market Conditions: A Perfect Storm for Private Equity

Current macroeconomic headwinds further heighten the risks. Higher interest rates and geopolitical instability (e.g., tariff-related volatility) have constrained exit options. IPOs, a critical exit route for large deals, fell by 7% in value in 2024, forcing sponsors to rely on secondary markets or corporate buyers. Meanwhile, venture capital—a cornerstone of private equity's growth narrative—saw asset values drop by 9% in 2024, signaling a broader downturn in speculative investments.

The Case for Caution: Prioritize Proven, Liquid Assets

401(k) plans are designed to provide retirement security, not speculative upside. Their success hinges on low-cost, liquid investments—like index funds or ETFs—that offer transparency, diversification, and the ability to withdraw funds without penalty.

Investment Advice:
1. Avoid Complexity: Stick to passive strategies with clear pricing and liquidity.
2. Demand Transparency: Reject any proposal lacking full disclosure on fees, valuations, and exit strategies.
3. Focus on Long-Term Certainty: Public equities and bonds, while volatile, offer liquidity and regulatory oversight absent in private markets.

Conclusion

Private equity's allure lies in its promise of high returns, but its current struggles—illiquidity, underperformance, and opacity—make it a poor fit for 401(k) plans. Retail investors, who lack the sophistication and resources of institutional peers, deserve protection from risky experiments. Regulators should resist pressure to expand PE access in retirement plans until robust safeguards, including stringent fiduciary standards and enhanced transparency, are in place. For now, the safest path to retirement security remains anchored in proven, liquid assets.