Self-directed brokerage accounts have been around for quite some time but don’t be surprised if your company’s human resources department and other plan literature doesn’t offer much information about it. The reason: the company who hosts your 401(k) plan is often not the company who handles the self-directed brokerage account. Therefore, when participants opt to allocate assets to the brokerage window, the core plan’s custodian loses out on the fees they earn on those dollars.
But that should not be a reason not to use it. Self-directed brokerage accounts are a great way to diversify your retirement account and gain access to stocks, bonds, mutual funds, exchange traded funds, and even add your financial advisor to your account for oversight and personalized service. The investments available in the core plan are usually limited to a list of 5-20 different mutual funds. Within the self-directed brokerage account, there are thousands.
Every employer offering a self-directed brokerage account has implemented different rules surrounding the use of the self-directed brokerage account. To understand the basics, first consider your 401(k) plan as having two separate compartments; the core account and the self-directed account. These are both within the 401(k) so do not worry that using the self-directed brokerage account is somehow creating a taxable event by taking a withdrawal.
The core account is the one that you’re probably accustomed to using. It commonly consists of 5-20 pre-selected mutual funds that are (hopefully) periodically reviewed and occasionally replaced for poor performance. This lineup will hopefully cover some of the spectrum of investments and include some U.S. large company stocks, U.S. small company stocks, international stocks, corporate bonds and government bonds. Almost always, these investments are in the form of mutual funds; active and passive (index). Commonly, 401(k) plans core accounts will offer target-date retirement funds that are supposed to be a single solution that simplifies investing. By selecting the target retirement date fund near your target year of retirement, you get a pre-made mix of investments. While these may help you to get a better mix of investments, there are shortcomings to this approach as well. A primary critique of these solutions are their often high management fees. READ MORE