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401k Self-Directed Brokerage Option

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Phillip Christenson

I’d like to thank Phillip Christenson, CFA for today’s post on the Self-Directed Brokerage option in your 401(k). Phillip is a Chartered Financial Analyst and financial advisor for Phillip James Financial located in Maple Grove Minnesota.  I highly recommend if you’re in that area you reach out to Phillip for further financial tips and help!

Thanks,

Stephen Reh CFA, MBA, CFP®

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Little Used Self-Directed Brokerage Option a Good Idea for Many 401(k) Investors

401(k) plans are a great way to save for retirement. They allow employees to put money away on a pre-tax basis to save for retirement. Even better, your employer will usually match some of your contributions up to a certain percentage. Many plans now even allow you to contribute after-tax dollars into a “Roth” 401(k). These are just some of the reasons 401(k) plans have become one of the primary ways people save for retirement. And as pensions become rarer, 401(k) plans are many times the only way people are saving for retirement. This makes them even more critical to a person’s financial future.  While these accounts have many benefits they still have some major drawbacks. One of the biggest of these problems is the number and quality of investment options employers offer within the plans. There are usually a handful of target-date funds (not my favorite investments), some actively-managed stock mutual funds, one or two bonds funds, and if you’re lucky a couple of index funds. As I mentioned, for many people this is their only source or retirement savings, so often a 401(k) can leave an investor missing out on key asset classes, under-diversified, and paying more expenses than necessary.

So, how can we address this major flaw of these accounts? With a Self-Directed Brokerage option. Not all 401(k) plans offer it but I have recently been seeing it in more and more plans. Soon I expect it to be a standard feature in most 401(k)s. So what is it? Well, this little known feature opens up a world of investments that an employee wouldn’t normally have access to within the constraints of a 401(k) while still keeping the tax qualified status of your account. Let’s say the average 401(k) plan has 10-15 investment choices, the Self-Directed Brokerage option provides access to literally thousands of investment choices. These additional investments will allow you to build a more complete portfolio. For example, you might want to be invested in Real Estate but your 401(k) doesn’t have any Real Estate Funds (REITs). With the brokerage option you would certainly be able to find the right Real Estate fund for you. This is where working with a financial advisor might be beneficial because they can help you wade through all the different choices and help you pick the best investments for your situation.

The self-directed brokerage option can also help you save money through reduced fund expenses. No matter which side of the investing coin you fall on (active or passive) you should be able to find lower cost investments using this feature. However, I have seen 401(k) plans that charge a small fee to utilize the self-directed brokerage option. It is usually a nominal amount and the savings from lower cost funds should more than offset the cost but it should be considered before making your final decision.

A 401(k) is very powerful tool that can help you save for retirement and save on taxes. But it gets even better if your plan allows you to choose the Self-Directed brokerage option. Check with your employer to see if it’s available through your retirement plan. You might also be able to find it by logging into your online account and looking for it yourself. Either way consider taking advantage of it to improve your overall retirement portfolio.

 

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Thanks again for posting Phillip

I agree with Phillip that self-directed brokerage can be a great option for investors working with advisors or for savvy DIY investors.  For those employers wondering if they should add the option, you may want to investigate your liability and the need to vet the options inside the brokerage window.  In general, I would be cautious for employers to offer this option.  Here is a link to an article in Forbes discussing it:

http://www.forbes.com/sites/ashleaebeling/2014/08/28/dol-questions-401k-brokerage-windows/

** The information on this website is intended only for informational purposes. Investors should not act upon any of the information here without performing their own due diligence. Reh Wealth Advisor clients should discuss with their advisor if any action is appropriate.