Thinking of spicing up your 401(k) beyond plain stocks? Experts warn a new twist on retirement accounts might be more complicated – and risky – than it looks.
Donald Trump signed an executive order in August giving Americans greater choice in how to invest their 401(k) savings.
Until now, most investors were limited to stocks. Now, retirement savers can also put their money into private real estate – such as rental properties – as well as private equity and cryptocurrencies like bitcoin.
Among the alternatives, property is attracting the most interest from investors.
However, experts caution that while real estate can diversify a portfolio, private investments are riskier and more complicated to manage than traditional 401(k) options.
Unlike stocks or mutual funds, private real estate is illiquid, meaning you can’t easily sell or trade it. That can be a problem for retirement accounts, which benefit from investments you can adjust, rebalance or cash out if needed.
‘Whether investing in private real estate is likely to be a ‘bad decision’ depends on one’s personal situation,’ Georgia Lord, financial planner at Corbett Road Wealth Management, told the Daily Mail.
‘I think a lot of investors expect more flexibility than private real estate offers. If you wish to be able to move in and out, adjust frequently or need regular access to your capital, you may be disappointed.’
A new twist on 401(k) rules means that investors can dump money into private real estate
Experts, such as Georgia Lord (pictured), have warned of the risks that come along with the 401(k) change
Private real estate funds usually lock up your money for years, and valuations are done infrequently. That can make it hard to know how your investment is performing.
She explained how this could hit 401(K) investors.
If you need to withdraw money – say, because you’ve reached retirement age and are taking required minimum distributions – you may not be able to sell the real estate quickly.
Even if you can, you might have to accept a lower price because it’s harder to find buyers, Lord explained.
This all comes down to the issue of liquidity. Unlike mutual funds or exchange-traded funds (ETFs), which can be bought or sold daily and provide instant diversification, private real estate doesn’t work that way.
Retirement plans benefit from liquid investments. ETFs pool money from many investors to buy a diversified portfolio of stocks, bonds and other assets.
These are more popular choices in retirement accounts because they make it easy to invest in a wide range of assets without needing to pick individual stocks or bonds.
Another hazard of real estate is rebalancing, Lord said. In plain terms, that’s the process of keeping your chosen mix of stocks, bonds, real estate and cash in proportion.
President Donald Trump signed an executive order in August to allow investors greater access to assets to 401(k) plans other than simply stocks
Real estate is a great way to diversify your portfolio, but private investments are trickier and riskier to manage
‘Investing in private real estate lacks rebalancing efficiency,’ she said. ‘Because private real estate doesn’t get priced regularly, investors might not realize their balance has drifted out of line until it’s too late.’
Because of those concerns, Trump’s order also directed federal agencies to revisit rules and clarify fiduciary responsibilities.
The goal is to make sure savers are protected, and that anyone managing 401(k) money is held to clear standards if they steer clients toward complex assets like private real estate.
Another potential downside is valuation. Unlike stocks, which trade every day with transparent prices, private real estate is valued infrequently through appraisals.
‘If you have a fund directly investing in a building, how do you get that money out?’ Craig Bitman, a partner at Morgan Lewis, told Realtor.com.
Even if you don’t want to take your money out of your 401(k), the question of what the investment is worth comes up. That can mislead 401(k) participants into thinking they have bigger – or smaller – savings than they really do.
It also complicates retirement plans, which must provide accurate account statements and comply with federal reporting rules.
Private real estate also comes with high management and performance fees, which eat into returns. And because many funds require large minimum investments, ordinary savers often can’t participate, raising questions about fairness in a system meant to offer equal access.
Private real estate typically locks up investors’ money up for years, and pricing is based on appraisals that happen infrequently
While some private real estate investments may work for pensions or endowments with long-term horizons and professional oversight, when it comes to 401(k)s – which prioritize liquidity, transparency, low fees and ease of access – they introduce unnecessary risk and complexity.
However, there are plenty of investors who like the idea of adding private real estate. While higher risk, it can also offer higher returns.
Real estate can outperform stocks when Wall Street wobbles. For example in the 2000 to 2002 dot-com crash, the S&P 500 fell about 37 percent across three years, while real estate averaged nine percent annual gains.
It can also help everyday investors access to a market that is usually reserved for the wealthy and can provide diversification beyond ordinary stocks and bonds.
But experts think everyday American savers should stick to another type of real estate investment, which works a bit more like a an exchange-traded-fund or stock.
For those interested in including real estate in a 401(k), experts recommend real estate investment trusts (REITs).
They operate more like stocks or ETFs, offering daily liquidity, public pricing, broad diversification, and lower fees.
‘Most of the investments you’re going to see implemented in 401(k)s are going to be more traditional REIT investments but in the private form,’ said Brian Pollak of Evercore Wealth Management.
So, should you build a rental empire inside your 401(k)? Maybe not.
Experts say private real estate might make sense for pensions or wealthy investors who can afford to wait years for a payout. But for everyday workers trying to secure retirement, it could leave their nest egg tied up in bricks and mortar – when what they really need is flexibility.