The 401(k) Smorgasbord
If you thought having 10 investment options in your 401(k) plan was overwhelming, imagine having thousands. By adding brokerage windows, also known as Self-Directed Brokerage Accounts (SDAs), to their retirement plans, more companies are offering a vast array of choices to their employees.
Cisco Systems, ITT, and Eastman Kodak are among the corporations that have added windows to their retirement plans in the past year. Plenty of state and city programs also feature them. These windows open to a brokerage account that gives you access to many or all of the nearly 7,000 mutual funds and exchange-traded funds in existence. Stocks and options also may be available, and you can usually trade as much as you like. SDAs can help you replace the core investments in your retirement account, but they are especially useful if you want to move to the more far-flung corners of the financial universe, such as emerging markets, international bonds, real estate, and commodities. Most plans don't offer such exotic choices. "The opportunity for diversification is a beautiful thing," says Rick Miller, an adviser at Sensible Financial Planning in Boston.
If your 401(k) plan offers an SDA, don't feel compelled to use it. Since Cisco added a window to its retirement plan in 2006, less than 3% of its U.S.-based workforce of 30,000 has signed up, Cisco spokeswoman Abby Smith says. Studies show participation rates at big companies run from 2% to 8%. "While we are pleased to offer our employees increased flexibility in investment choices, we realize this is a program that is best suited for astute investors," Smith says.
Do not even consider opening up an SDA unless you can commit at least $50,000 of your 401(k), says Kay Conheady, a fee-only financial adviser at Apropos Financial Planning in Rush, N.Y. "It's not easy to mimimize the costs if you're investing in small accounts."
Although taxes aren't a concern in a tax-deferred SDA, you do need to watch the costs. Commissions vary from provider to provider, but it typically costs $10 to $15 per trade. If you are a frequent trader, that can add up. Administrative fees to cover record keeping and other expenses can be as high as $100 per year, but some employers absorb those costs.
If you are buying mutual funds, you also need to pay attention to the underlying costs and whether you'll pay a sales charge. To get the best deal, see if your plan offers funds without transaction fees. If not, you may have to pay $75 for each purchase.
When you are ready to climb through that window, start off slowly. Vincent Joseph, 34, a controller at oil giant Schlumberger in Houston, spent two years selecting the 12 funds he needed for his asset allocation plan. Although employers don't offer help in choosing investments, SDA providers such as Fidelity Investments and Charles Schwab can pair you with an adviser.
Make sure you also consider the time it will take to monitor your investments. Charlene Williamson, 56, of Dallas, goes far beyond what most people do in a retirement account. Following a sophisticated strategy that uses calls, puts, and stocks, she spends about six hours a month trading in her husband's retirement SDA. (She oversees the family's finances.) But it has been worth it: After the Williamsons made the switch, the portfolio rose 8% in four months, she says. Some people like the flexibility of an SDA, but they don't have the time or savvy to run it right. So they hand control to an investment manager. In fact, one-quarter of SDA assets at Schwab are managed by the financial advisers of plan participants.
Just because the window is open doesn't mean the sky is the limit. "Most plans restrict the funky stuff," says Robert Jesch, a director in Schwab's corporate and retirement services division. That includes futures, currencies, private placements, and derivatives. Your employer may also set a cap on how much of your retirement account you can invest through a brokerage window. If stocks are offered, plans usually restrict purchases to companies listed on major exchanges. In other words, you won't find any "pink sheets" (over-the-counter stocks) hanging in these windows.
By Lauren Young