Crypto grabs so many headlines and has been trendy for sure. Over the past several years, we've seen the collapse of some crypto firms, jail time for some crypto operators, the launch of crypto ETFs, and a lot of volatility both up and down.
Still, there is a lot of buzz and talk about where crypto sits in one's investment strategy if at all. When it comes to 401(k) plans, let’s take a step back and look at objectives and regulations around retirement plans and consider when any asset class is a good or bad fit for a 401(k).
The 401(k) regulations are established to help employees build for tomorrow without taking on undo risks. For employers and/or advisors that support the investment decisions in a 401(k), they take on quite a bit of responsibility when they offer a 401(k). When it comes to investments, they are responsible for the options made available and can be personally liable for employee decisions (losses) unless they take advantage of an important safe harbor that protects employers. This is known as 404(c) and most all 401(k) plans are designed to be 404(c) compliant for this reason.
In understanding regulations and what’s required on the investment front, there are several essential things to know – all of which would make adding crypto to a 401(k) pretty dicey at this time. These include:
- Investments in a 401(k) must offer diversification. This is both to offer the ability to achieve returns, but to also minimize against the risk of large loss. It’s why you see diverse stock, bond, and cash options in most every 401(k) plan investment roster.
- The investment line-up must be managed under the “prudent man” rule. This should really be called the “prudent expert” rule. Investments made available in a 401(k) from which all employees choose, must be evaluated at the level of someone skilled in the field. It’s why many businesses outsource this role to an ERISA 3(38) advisor who often have CFAs, resources, and financial tools to help determine an optimal fund line-up. Evaluating funds by asset class, considering diversification of the funds, fund expenses, historic performance, a fund’s market cap to survive long-term, and a whole host of other financial insights are needed to do this well.
While crypto is fun to discuss around the water cooler, crypto appears to be missing the bar on several fronts to be considered a “prudent” investment in a 401(k) line-up as we stand here today. Here are the concerns for adding to a retirement plan:
- It is highly volatile. So far crypto appears more volatile than broad-based stock funds and definitely more so than bonds. Consider the big drop in 2022 and even the rise since. It’s hard to argue crypto minimizes risk.
- Unlike the stock and bond markets that have been around for well over 100 years, crypto is young, is unregulated, and not even legal in some large economies like China. Will there be many crypto companies that survive or just a few or worse?
- The launch of spot ETFs for Bitcoin does not appear to change or improve any investor risks. The underlying asset, in this case Bitcoin, still lacks regulatory oversight, lacks investor protections, remains highly speculative/volatile, etc. The SEC approval granted for these ETF’s governs the issuance and trading of the ETF on exchanges only, it does affect the regulatory status of the underlying asset (Bitcoin) in any way.
- It’s unclear how crypto drives on-going value at this point other than trading. There may be some person-to-person conveniences, but it can be argued there are substitutes like Zelle and Venmo. Crypto is unlike a company’s stock which value is derived from the income the company can create. Crypto doesn’t provide interest like cash or bonds. And, most people don’t understand crypto, even less so than stocks and bonds.
- Lastly, added expenses to offer crypto within a 401(k) plan may be considered high which is another red flag.
Remember, a 401(k) is all about sound investments meant to help employees build a nest egg over time. A 401(k) is not meant to be a get rich quick scheme or like playing the roulette wheel in Vegas.
Crypto is young, and until it matures and becomes a proven asset class that offers real value, it will likely continue to miss the bar to be included in retirement plans anytime soon – even if some enable it. Employer and advisor fiduciary duties make it risky to offer crypto in a 401(k) plan. If you have the income and can afford to play around with it on your own, great. It's just not something to count on for your retirement, at least from what can be discerned at this point.
This blog was updated and offers perspective on crypto ETFs.