Investing in cryptocurrencies has not made it to many retirement plan menus just yet. However, earlier this year Coinbase Global, a cryptocurrency exchange, announced that it will work with 401(k) providers to invest up to 5% of their 401(k) contributions in a variety of cryptocurrencies, opening the door to direct crypto access in retirement plans. This news comes after the US Department of Labor’s (DOL) information letter in June of 2020 indicating, in limited circumstances, that it would allow 401(k) plans to indirectly invest in private equity funds. Although private equity and direct cryptocurrency are not the same, there is growing pressure and a trend to allow more alternative assets in defined contribution plans because of the current low interest rate environment and meager return prospects of traditional bonds.
For now, the DOL has said that it is concerned about the fiduciary implications of investments with cryptocurrency exposure. Acting DOL Assistant Secretary Ali Khawar, at a conference in the summer of 2021, specifically cited issues with cryptocurrency’s “noise”, “volatility”, and “very little transparency.” He stated that the DOL is actively preparing guidance around cryptocurrency which will be released soon.
While the debate about, and eventual regulation of, cryptocurrency still has a long way to go, it seems like a good time to take a step back and think about what a retirement plan fund line up should look like, and what plan administrators should do when they’re asked, or are considering, to put risky or non-traditional assets in their fund line-up.
We’ve previously written about the core elements of a successful 401(k) Plan , and when designing your plan’s fund menu it is probably best to embrace the Navy’s KISS principle. A core menu of diversified index funds gives the “do-it-yourselfer” plenty of choice. For those who prefer to be less involved, a suite of target-date funds designed to adjust allocations over time based on expected retirement date is appropriate and also can serve as the Qualified Default Investment Alternative (QDIA). The menu options should really be low-cost, index funds in order to avoid running afoul of fiduciary regulations.
When considering non-traditional or riskier asset classes, like cryptocurrencies, private equity, high yield or emerging market bonds, emerging market equity, or even specific sector funds, it’s best to remember that as plan administrator, you are a fiduciary, and must act in the best interest of the participants and their beneficiaries. Creating a fund line up with these riskier assets may be appropriate for some participants who are more educated and understand the actual risks they are assuming; however, it creates the possibility for other participants to overly concentrate their portfolios in unsuitable investments.
Even with vast amounts of “past performance is not indicative of future results” disclosures across all the literature participants see, investors tend to chase and react to recent performance. Jack Bogle, founder of Vanguard, famously noted that “money flows into most funds after good performance and goes out when bad performance follows.” If your fund line up is filled with risky and volatile investment options, it’s likely that your participants will be moving money in and out, often at the wrong times. When things go bad, not only will participants lose money, but you as the plan administrator also open yourself, and the plan sponsor, up to potential liability.
In a landscape with an increasing trend of ERISA lawsuits, doubling in number from 2018 to 2020, it is important to be prudent when making decisions on what to include in your fund line up. It’s well documented that high fees are drivers of poor performance, and the underlying cause for many lawsuits. Non-traditional and riskier asset classes, due to their structures, strategies, and limited adaptation tend to have above average expense ratios. If you’re not monitoring the line-up properly, and documenting reasons why you believe more expensive funds are appropriate, you may be found in breach of your duties.
Participant education is also a key component and responsibility of managing a 401(k) plan. When providing education about the plan’s investment line up, it should be noted that participants have the tools to build a well-diversified, low cost, core portfolio. For more esoteric, non-traditional, and riskier assets, it may be better to suggest participants hold these in their other self, or advisor-directed investment accounts. If their only long-term savings is in your plan’s 401(k), it’s likely not appropriate for them to be investing in riskier asset classes.
The best choice, as is true in many aspects of life, is sometimes to avoid the worst choices. Avoiding risky funds that can have big declines in short periods of time can help protect participants from making poor choices and impairing their long term retirement success.
Buying Bitcoin cryptocurrencies in a 401k