The U.S. Department of Labor came out this week with an unusually strong warning about cryptocurrencies pushing their way into 401(k) retirement accounts. Over the last few months, some financial institutions have started marketing crypto investments as potential options in these highly regulated accounts, and that’s a problem according to the DOL.
“At this early stage in the history of cryptocurrencies, however, the U.S. Department of Labor has serious concerns about plans’ decisions to expose participants to direct investments in cryptocurrencies or related products, such as NFTs, coins, and crypto assets,” the department writes.
They’re correct. Pushing crypto investments onto people, the vast majority of whom would have a hard time even knowing what the total of fees charged to their accounts are, should be beyond any reasonable professional ethics in the financial industry. This is asking people to potentially take a deep and unpleasant bath and undermine value they’ve built up over many years and will need in retirement.
The allure
Saving for retirement has become a troublesome burden for most people. The introduction of the 401(k) plan happened through a 1978 congressional act that created an unanticipated loophole. Originally intended to allow people to avoid taxes on deferred compensation, benefits consultant Ted Benna realized that this provision could be turned into tax-friendly retirement programs in 1980, with employees saving pre-tax money that was matched by an employer. The next year, the IRS issued rules to allow 401(k) funding through payroll deductions.
The race was on as companies quickly took to the concept. But there was a second unanticipated result. Businesses increasingly decided to make 401(k)s, which were supposed to be for additional retirement savings over and above a pension plan, the only retirement option. It saved the companies money by shifting all responsibility onto the shoulders of the employees. Coincidentally, this was at the start of the long stretch where household income effectively froze, barely growing with long-term inflation.
Getting good returns was critical and became even more so after the Great Recession. The Federal Reserve crushed interest rates to stimulate the economy. The recovery still took more than ten years, the rates remained low, bond purchases by the Fed flooded the monetary system with money, fixed income investments, once critical to retirement, were doing terribly, and stocks became incredibly expensive over time because the people with serious cash were driving up the cost of investments.
Many people are desperate for a good return, setting the stage.
The promise
Cryptocurrencies were originally an oddity. Now they’re all over the place, but they are a wildly volatile and unreliable asset class. Value comes from belief and reality. Real estate has value because people need places to live and companies, locations to do business. The price can get driven to ridiculous levels, but there is always some baseline of actual value. Sovereign fiat currencies like the dollar or euro will shift in value, but typically maintain a base level because they’re backed by nations that have massive collective resources.
Cryptocurrencies, however, rest pretty much completely on trust—and a whole lot of attempts at market manipulation and hucksterism, if you take a glance at how people talk about this on social media, particularly Twitter. The new form of finance, many say. But anytime you hear someone go on about how something basic is now completely different from how it once was, be careful and keep a hand on your wallet. During the dot com debacle (yes, some giants emerged, but a whole lot of companies went under), people were saying the rules of business were different, that profit wasn’t as important as getting attention. In general, it was a ludicrous statement, and laughable, but the humor was quickly bitter.
However, people hear about the massive increases in values of things like Bitcoin, how cryptocurrencies are a great inflation hedge and store of value, how everything will center around them. But out of the reportedly 12,000 or more cryptocurrencies in existence (a number that’s doubled over the past year), according to the Motley Fool, plenty have burned to the ground. There’s no guarantee that any particular one couldn’t. (Remember, right before the Great Recession, millions of people were sure that real estate prices couldn’t drop.)
Does any given crypto asset hold value? Sure, so long as people keep valuing it at the current price or higher. No investment comes with an absolute guarantee. Even gold, which is a classic hedge against inflation and odd times, rises and falls in value.
The problem
People already can invest in cryptocurrencies, and if you’re risking money that you can afford to lose, there’s nothing intrinsically wrong. Maybe the bet will pay off big.
Any financial advisor or analyst should understand this principle. Risk brings the possibility of reward, but also of loss, and risk management suggests not putting the money you really need to be in place for the future into something that could quickly send it down the drain.
The DOL pointed out several clear risks that cryptocurrencies can pose to a retirement account:
· “Valuation concerns. Financial experts have fundamental disagreements and concerns about how to value cryptocurrencies. These concerns are compounded by the fact that cryptocurrencies are not typically subject to the same reporting and data integrity requirements that apply to more traditional investment products. Scammers have used misleading information to inflate the price of cryptocurrencies, and then sold their own holdings for a profit before the value of the currency drops.”
· “Obstacles to making informed decisions. These investments can easily attract investments from inexperienced plan participants with expectations of high returns and little appreciation of the risks the investments pose. It can be very hard for ordinary investors to separate fact from hype. When fiduciaries include a cryptocurrency option on a 401(k) plan menu, it signals to participants that knowledgeable investment experts have approved it as a prudent option. This can mislead participants about the risks and cause big losses.”
· “Prices can change quickly and dramatically. Cryptocurrencies’ prices have been extremely volatile. For example, in just one day last December, the price of bitcoin dropped by more than 17 percent. These large swings can leave participants vulnerable to significant losses.”
· “Evolving regulatory landscape. Laws and rules are swiftly evolving. For example, the president’s recent executive order directs federal agencies to study risks and policy approaches to digital assets, including cryptocurrency. Changes in the United States and globally may impact existing regulatory frameworks.”
It’s not just that consumers should know this. Financial services companies are supposed to have a much clearer idea, particularly when dealing with 401(k) plans. The DOL issued a separate warning, with the underlying tone of a threat, to such businesses. The law and regulations that govern 401(k) plans require the firms to act “solely in the financial interests of plan participants.” If they don’t and people have losses as a result, the supposed professionals involved become personally liable.
That’s fine if there is enough money to cover the losses. If not, what’s even a court to do to make people whole? Last year, cryptocurrency exchange Coinbase worked with a small 401(k) provider to offer crypto exposure in retirement plans. Notice the qualifier “small.” As in maybe without enough money to cover risky investments if the federal government decided that the promotion of crypto in a 401(k) plan wasn’t keeping with fiduciary responsibilities.
“Crypto itself is fascinating, and intriguing as it starts to develop, but it’s still in its early phases. And it is definitely not appropriate for retirement investing,” David John, a senior strategic policy advisor to the AARP Public Policy Institute, told Forbes. “The fact is that for retirement investing, you want growth, and you want a limited amount of volatility. The older you get, the less you want your portfolio to gyrate up and down, because it makes it very hard to plan your retirement income.”
The risks in cryptocurrency trading are enormous and not what would typically be considered as prudent for a retirement account. But the amounts of money can set those in the crypto industry drooling, because the more money invested in cryptocurrencies, the more “faith” in the “value” is shown and, in theory, the higher those values should go.
When you need to retire, you want to know that what you invested in didn’t go bust along the way and that you can redeem the asset for cash when you need it. Cryptocurrencies, at least as they stand now, with prices dropping in the face of economic uncertainty and inflation, aren’t the smart choice for money you can’t afford to lose. The DOL is doing the wise thing by raising concerns now and reminding financial services firms of their responsibilities.