Cryptocurrencies Pose High Risk to 401(k) Portfolios, Government Watchdog Warns

December 7, 2024 TruthUSA

Digital currencies are found to be less efficient as a stock diversifier compared to safe haven assets such as gold.

Cryptocurrencies in 401(k) retirement accounts expose portfolios to high risk of decline, with the value of these assets largely dependent on investor sentiment rather than actual market usage, according to a recent report from the U.S. Government Accountability Office (GAO).

“GAO’s analysis of investment returns indicates crypto assets have uniquely high volatility—a measure of their riskiness to participants—and their returns can come with considerable risk,” said the Dec. 4 report from the watchdog.

GAO compared five crypto assets available for 401(k) plans against the S&P 500 index between 2021 and 2023. Volatility ranged from 4 to 12 times higher than index volatility, and two to seven times more volatile compared to stocks such as Google or Apple.

The impact of crypto assets in retirement portfolio diversification remains “unclear,” GAO said. Diversification is done to minimize risk to the portfolio while ensuring maximum possible returns. In order to be considered a diversifier, the asset’s performance must not be positively related to others in the portfolio. If the diversifier asset goes down when other stocks tumble, it essentially defeats the purpose of diversification.

All five digital currencies reviewed by GAO were found to have a higher positive correlation with the S&P 500 compared to gold, another asset considered a diversifier. Because cryptos are highly volatile and have a positive correlation to traditional investments like stocks, this results in “larger losses to a portfolio during market downturns” if cryptos are part of the asset mix.

According to market analysis website, CoinMarketCap, Bitcoin continues to dominate the digital currency sector, holding more than 53 percent market share. One Bitcoin is worth nearly $100,000 at the moment, a spike of more than 135 percent from the beginning of the year.

“Unlike traditional stocks, investors in crypto assets typically do not own blockchain technology and generally do not have an entitlement to income streams from investment in the same way that holders of stocks have rights to dividends from an operating company,” the report noted.

Moreover, cryptos do not have a “well defined use” like other assets. For instance, gold has demand as jewelry and in industries for its corrosion resistant and conductive properties.

Digital currencies “mainly derive their value from investor sentiment rather than through tangible company assets or cash flows,” the report noted. “If market sentiment shifts to a new crypto asset, older crypto assets could become obsolete and lose their value.”

The GAO report also listed out some regulatory issues on crypto use in retirement assets.

The Employee Benefits Security Administration (EBSA) does not collect data that enables the agency to easily identify 401(k) plans offering crypto assets and “assess their effects on participant savings,” it noted.

EBSA is an agency within the U.S. Department of Labor that oversees employee-sponsored retirement plans such as 401(k). “Certain crypto assets continue to trade in markets that do not have investor protections or comprehensive oversight,” GAO said.

The agency noted that crypto assets currently are only a “small part” of the 401(k) offerings, identifying 69 such investment options.

Protecting Americans

The GAO report was issued from a request made in 2022 by Rep. Richard Neal (D-Mass.) after retirement plans started offering cryptos.

Following the release of the report, Neal pointed out that millions of Americans invest trillions of their savings in these plans. As such, “it is incumbent on the federal government to ensure proper oversight,” he said, according to a Dec. 4 statement.

The crypto market “has not been fully subjected to proper oversight and regulation,” Neal said.

“As a result, as this report outlines, it has brought uniquely high risk to retirees. Americans must be confident that their investments are secure, and do not face unnecessarily high volatility, cybersecurity, and theft risk.”

In 2022, EBSA asked fiduciaries offering retirement plans to “exercise extreme care” before adding digital currencies to retirement portfolios.

The agency said it had “serious concerns” about allowing crypto inclusion, noting that these assets “present significant risks and challenges to participants’ retirement accounts, including significant risks of fraud, theft, and loss.”

Last year, the White House also raised concerns about the issue. It suggested not to pass any legislation that would allow institutions such as pension funds to “dive headlong” into crypto assets.

“In the past year, traditional financial institutions’ limited exposure to cryptocurrencies has prevented turmoil in cryptocurrencies from infecting the broader financial system,” it said.

“It would be a grave mistake to enact legislation that reverses course and deepens the ties between cryptocurrencies and the broader financial system.”

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