Having some crypto in your 401(k) is neither irrational nor exuberant

The biggest retirement plan provider in the United States, Fidelity, just announced plans to offer individuals the opportunity to invest in bitcoin through their 401(k) retirement accounts later this year. With 20 million plan participants accounting for $2.7 trillion in assets, Fidelity just brought a somewhat controversial strategy into the mainstream.

It’s not surprising that Fidelity was the first tradfi asset management firm to stake out its territory in this space — the company has been ahead of its peers in launching digital asset products under the tenure of CEO Abigail Johnson. It launched its first crypto-related offering in 2018 when it began to hold digital assets in custody for institutional investors.

The news marks a pivotal moment in the growing movement to expand access to alternative investments — a goal that can be seen as either laudable or risky, depending on whom you’re asking.

First, let’s start with the criticism, because skepticism over crypto’s expansion is understandable given the asset class’ reputation for scams and volatility. What’s more, it might not even be a good investment; bitcoin hasn’t proven itself to be an effective hedge against inflation and has lost over 40% of its value since peaking last November.

With that in mind, it’s easy to see why regulators don’t love the idea of allowing access to crypto in retirement accounts. The U.S. Department of Labor said in a directive last month that fiduciaries should “exercise extreme care” before doing so, citing crypto’s historical volatility, potentially inflated valuation and fears about custodial issues given the near impossibility of recovering crypto from a wallet if one were to forget their password.

And it’s not just regulators raising an eyebrow, though they seemingly have good reason to do so. Companies like Fidelity obviously have a profit incentive to launch crypto products because they can earn more fees, which begs the question of whether they’d expand into digital assets to make a buck while convincing average retail investors to shoulder all the risk. If crypto crashes, after all, retail investors could be left holding the bag after gambling away their retirement savings. That can’t be good, right?

If you want to allocate a reasonably small percentage of your savings to crypto, and you’re aware of the risks, it could make sense to put money into this growing asset class that could very well continue appreciating over the long term.

Wrong. Now, let me tell you why Fidelity offering crypto in retirement plans is a huge win for pretty much everyone who isn’t ultra-wealthy.

Crypto has promised to “democratize” a lot of things and largely hasn’t delivered. Individual wealthy “whales” have benefited from crypto’s rise to an extent that most average individuals haven’t. The wealthiest 82 individual crypto wallet holders account for almost 15% of the total supply of bitcoin, according to River Financial.

One key factor behind why wealth is so concentrated in crypto, much like with other alternative assets, is that average investors don’t enjoy the same access to top-tier investment opportunities that the wealthiest folks have.

The demand for crypto investment opportunities clearly exists, though, and data show it is particularly strong among women and people of color, who see an opportunity to build wealth through the emergence of a nascent asset class. But average investors have been shut out of many of these opportunities through either regulation or a lack of infrastructure available to them.

Retail investors’ lack of access to premium investment opportunities is, of course, a much broader and more nuanced issue, but Fidelity’s announcement will help remove one particular barrier. While retail investors can fairly easily use a platform like Coinbase to purchase the most popular cryptocurrencies, there are no mainstream solutions that allow them to do so in a tax-advantaged way. A solution like this doesn’t exist in the mainstream yet because companies are hesitant to bear the regulatory and reputational risks associated with being the first to roll out a product that has been so heavily criticized by regulators.

Fidelity has decided that taking that risk is worth the tradeoff, and retail investors are likely to benefit as a result.

As an investor, if you want to invest in anything riskier than the market — like crypto — a tax-advantaged retirement plan makes sense as a place to do it. Risk and return are correlated, and to even have a shot at outsized returns compared to the average index fund tracking the overall market, an investor would likely need to take an outsized risk.

This isn’t suitable for everyone, of course — if you’re nearing retirement age, it’s probably not a great idea to invest in risky assets. It also isn’t prudent to bet your entire life savings on a single altcoin. But if you want to allocate a reasonably small percentage of your savings to crypto, and you’re aware of the risks, it could make sense to put money into this growing asset class that could very well continue appreciating over the long term.

With a 401(k), you contribute pre-tax dollars and only pay taxes on those dollars at retirement, provided you don’t withdraw the funds early, so if you are fortunate enough to make, let’s say, a 20% return on those dollars (well above the 10% or so that the S&P 500 has returned on average over its lifetime), you’re making that 20% gain on a larger pool of money in the first place.

If you invested the same percentage of your annual income into a regular brokerage account, you’d have to pay taxes on it first and would have less capital to appreciate over time. Investing in a risky asset through a retirement account also has the added benefit of giving people more time to recoup any losses or weather volatility given the longer duration of their investment.

Ultra-wealthy investors have been using this strategy for years. Take billionaire Peter Thiel, for example, who grew his Roth individual retirement account from $2,000 to $5 billion in 20 years, tax-free, ProPublica reported last year. Investing one’s retirement savings in alternative assets like Thiel did has long been legal, but it has been largely inaccessible to non-billionaires because of a long-standing lack of tech and asset management infrastructure to enable these strategies. Regulators haven’t been encouraging companies that want to innovate in this space, especially in crypto, given the lack of clarity from the U.S. Securities and Exchange Commission on how digital assets should be defined, let alone regulated.

(Note: I’m not the biggest Thiel fan, especially after his tirade at Bitcoin Miami against anyone who dares to even so much as question his favorite cryptocurrency, but capitalism is the game we’re all playing, whether we like it or not, and, admittedly, Thiel has played it intelligently.)

Startups like Alto IRA and Rocket Dollar have cropped up in the past few years to fill the gap, offering individuals the ability to invest in alternative assets, including crypto, through their tax-advantaged retirement savings accounts.

Alto IRA CEO and founder Eric Satz, an experienced investor who had worked in financial services for most of his career, started the company after trying to go through the process of investing his retirement savings into alternatives and running into numerous logistical hurdles.

Less than 2% of the $35 trillion in assets sitting in individual retirement accounts is invested in alternative assets like private equity and crypto, Satz told TechCrunch in January. In contrast, most high-net-worth investors and institutions have a much larger percentage of their capital in alternative assets, ranging between 15% to 80%, Satz said.

When I caught up with Satz about the new Fidelity offering, he pointed out that while it will help legitimize crypto as an investment opportunity, adoption may be slow because employers, who have discretion over the products their employees can access through their 401(k)s, may initially be hesitant to offer it.

Is it risky to invest your retirement savings in crypto? Absolutely, yes, it is, and it should be done with prudence, preparation and education. But individuals can take whatever risks they want in the public markets, too, and just because companies disclose their financials publicly doesn’t necessarily mean they’re safer investments.

If one wanted to pour their life savings into a penny stock peddled by the likes of Jordan Belfort or the more innocuous Jim Kramer, they could do so pretty easily through any number of investment platforms including Schwab, Fidelity, Robinhood or Public. The concern over crypto specifically seems almost condescending, as if regulators think retail investors are too stupid to understand the risks.

Obviously, I’m not a professional financial adviser. You should seek expert advice and do your homework before you empty your 401(k) savings into crypto, but the same disclaimer applies to any investment, whether it’s in stocks, bonds or digital assets.

Fidelity’s move is a step in the right direction because it gives retail investors the choice and the tools to deploy an investment strategy that could potentially be very lucrative. While the firm has been an early adopter of crypto compared to other traditional financial institutions, it’s certainly not alone in its broader strategy. Vanguard, for one, launched a low-cost private equity fund offering to some of its retail clients last year.

In the past, only the ultra-wealthy have benefited meaningfully from the explosion of young asset classes like private equity and venture capital. Whether crypto will be able to live up to its promise of high returns over the long term still remains to be seen, but participation in the market should be a choice afforded to all individuals rather than discouraged in the name of investor protection.