Should You Include Private Equity in Your 401(K) Plan?
Private equity refers to ownership of a company that is not publicly listed but is held privately by a limited number of investors. As an investor in private equity, you provide capital to a firm which then uses that capital to take a company private or to restructure a company with the intention of reselling it at a profit. Private equity investments come with several risks, including having complex operational and investment structures, the inability to redeem investments at any given time, and potentially higher fees.
However, including private equity in a portfolio with a long time horizon can enhance the portfolio’s long-term returns as compared to a portfolio invested in only publicly traded securities.
A 2018 study by Georgetown University’s McCourt School of Public Policy’s Center for Retirement Initiatives in conjunction with Willis Towers Watson concluded that adding private equity to a diversified target-date fund could increase the annual income stream between 6% and 13% provided a full-career employee’s defined contribution balance is converted to an income stream using an annuity.
The study does point out that the performance differential between the best-performing and average-performing private equity managers is wider than in many other categories. High levels of skill and due diligence are required to reap the benefits of including private equity as an asset class in a portfolio.
While it may be exciting to have a new asset class as part of your 401(K) plan, it’s important to understand the risks that come with private equity, the level of due diligence the plan sponsor is performing prior to adding private equity, and any additional fees you may be exposed to.
Before including private equity in your 401(K), we recommend you speak to a financial advisor to ensure this strategy is right for you.