If you’ve looked at the investment options in your workplace 401(k) retirement plan, chances are you’ll see mutual funds that put your money into stocks, bonds or cash and cash equivalents. Those have been the options available ever since 401(k) plans were introduced in 1978. Now, a new study from the Center for Retirement Initiatives at Georgetown University finds that adding alternative investments to the mix would boost 401(k) returns by 8% in the long run. Here’s what you need to know.
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The study from the Center for Retirement Initiatives at Georgetown University says that the improved diversification offered by including alternative assets in the portfolios of 401(k)s and similar defined-contribution retirement plans could deliver greater returns and improved retirement income for millions of U.S. workers.
Alternative investments include a range of options from hedge funds and commodities to collectibles and structured financial products, such as credit default swaps and collateralized debt obligations.
In this case, the Georgetown study focuses on three alternatives: real estate, private equity funds and private credit. And it examined how adding these alternative assets to target date funds (TDFs) could boost your retirement savings significantly.
“The Expanded TDF, which includes allocations to private equity, real assets, and private credit, further improves long-term retirement income expectations and worst-case results by 8% and 6%, respectively,” the study concluded.
Why More 401(k)s Are Investing in TDFs
Target date funds are a type of mutual fund that adjusts the asset mix and risk profile of the fund as time passes from a more volatile stock-heavy mix in early years to a more stable portfolio as the fund’s target date approaches.
This investment typically focuses on a specific year when an investor is expected to start withdrawing money in retirement, such as the Vanguard Target Retirement 2035 Fund.
Ever since the Pension Protection Act of 2006 was signed, employers have been allowed to automatically enroll workers into workplace 401(k) retirement accounts, with that money going into a Qualified Default Investment Alternative, which typically uses target date funds. The result has been a surge in the use of these funds.
According to the report, at the end of 2021, “64% of Vanguard plan participants were solely invested in a default investment program compared with 7% at the end of 2004. Of the plans with automatic enrollment … 98% chose a target date fund as the default.”
Target date funds will see even more activity now that the recently signed Secure 2.0 Act has been signed. Starting in 2025, companies that add a new 401(k) and 403(b) plan will be required to automatically enroll their workers, with a minimum contribution rate of 3% to 10%. The minimum contribution amount will increase 1% each year up to 15%.
Benefits of Adding Alternative Investments to Your TDF
The study points out that alternative investments can have many benefits, from higher returns to inflation protection and reducing portfolio risk.
Real estate, for example, can provide high inflation-sensitive income and capital appreciation. Private equity, comparatively, could offer higher long-term returns because those investments are in fast-growing small and mid-sized private companies. And private credit, like bonds and securitized loans, could offer investors higher yields with lower overall risk.
And while TDFs are growing in popularity, the study also acknowledges that the design of DC plan investments need to continue evolving to support growth, smooth risks and enhance retirement income outcomes for workers.
“DC plans are still not harnessing their full potential because the investment of the contributions is allocated almost exclusively to public stocks, investment-grade bonds and cash,” the study says. “Because plan participants fully absorb the gains and losses of their accounts, market events can drastically affect their ability to retire.”
Bottom Line
A new study from the Center for Retirement Initiatives at Georgetown University finds that adding alternative assets to 401(k) portfolios and other defined-contribution retirement plans could deliver greater returns and improved retirement income for millions of U.S. workers. But there is still additional room to support growth and minimize risk for retirement investors.
Retirement Planning Tips
- A financial advisor can help you create a comprehensive financial plan to help you pay for retirement. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- If you’re looking for different ways to invest for retirement, here are 13 financial investment and examples to consider in 2023.
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