Legal Intern, Manhattan Institute's Center for Legal Policy
One frequently cited problem of 401(k) plans is that the volatility of the market puts workers at risk of losing their retirement savings at a moment's notice. In order to hedge against this problem, lawmakers tend to argue that safer alternatives, such as defined-benefit plans or 401(k) plans with limited exposure, should be the industry norm. In terms of both approaches, the argument is that the little to no market exposure will ensure worker returns upon retirement. An oft-overlooked consideration, however, is whether the extent of these returns is sufficient to ensure a stable retirement. Generally, safe investments mean lower yields, which in turn must outpace inflation to allow workers to reap even minimal rewards.
In order to offset this problem, another alternative is to utilize 401(k) plans that take on greater risk, but are able to hedge against this risk by diversifying portfolios to allow for investments with longer time-horizons to counter the effects of short-term volatility and provide returns much greater than the rate of inflation. Scott Higbee, a partner at the global private markets firm Partners Group, argues in today's Wall Street Journal for just such an approach:
Meanwhile, more than 50 million Americans rely on 401(k) plans for their retirement that typically are self-managed and restricted to a combination of traditional assets of stocks, bonds and cash. These defined-contribution plans generally don't provide investors with the opportunity to add a range of alternative assets to the mix. Given the current dismal yields on mainstream fixed-income securities, they should.
Some self-directed retirement savings vehicles such as IRAs allow investors typically with a net worth in excess of $2 million (excluding their primary residence) to invest in alternative assets such as private equity and real estate. But most 401(k) participants don't meet these thresholds and most plans are not designed with portability and liquidity in mind.
By opening up the alternative asset option for all investors, the government would allow 401(k) workers a better chance at securing a stable retirement, while minimizing the concomitant risk of such an approach. If this shift in policy were accompanied by a shift in the regulatory scheme to allow fund trustees a certain degree of immunity from alternative-asset related litigation, while preventing these trustees from aggregating risk in a small number of assets, the incentive to diversify into alternative-assets would certainly be extant. If this scheme proved successful, it could provide an impetus for the reconsideration of the defined-benefit system as well, which would save the government billions in public worker costs. Within the confines of a wise regulatory framework, this is an experiment that seems worth any potential costs.