Make the Most of Your 401k Self Directed Brokerage Account.

This article is for the lucky few who have a 401k plan with a self directed brokerage account option in place. It will help you understand how it works and how best to use it.

With the passage of the Pension Protection Act of 2006 a platform for plan participants to choose investments other than the lineup of mutual funds offered by the traditional 401k plan is gaining traction. This platform is called the Self Directed Brokerage Account or SDBA. Each plan provider like Fidelity, Hewitt and Schwab has named it something a little different but the concept is the same. It allows the plan participant greater choice in the investment products available for their company retirement savings account.

Typically, the plan participant must elect and set up a SDBA, convert some portion of their traditional 401k assets to cash, journal the cash to the Self Directed Brokerage Account and then put the money to work. Each plan is different so it is important for the participant to understand any limitations placed on the option by their employer at the suggestion of the plan provider. In addition, the participant should look closely at any annual fees as well as transaction costs associated with activity in the account. This information will be available from your Human Resources Department. Ask for a document called the Summary Plan Description or just ask someone in HR to talk you through it.

Once the account is set-up and funded it is time to ask some questions. How much time do I really want to commit to making investment selections? If I have the entire investment universe from which to choose how will I actually do that? How can I monitor those investments? And, how do I manage unrealized gains and losses? Some suggestions along those lines are as follows: Eliminate from consideration all mutual funds (why bother with the SDBA if you are just going to buy another fund?); Eliminate from consideration individual stocks because in order to control your investment risk you will need a portfolio of at least ten to fifteen stocks. (Be honest with yourself, this is not your profession, this is not your full time job and this IS your serious money.)

In my opinion, the most sensible approach for a plan participant is to focus on lower cost and much better performing exchange-traded funds (“ETFs”). You will get the diversification of mutual funds without the high fees which in turn improves their performance. You can buy or sell ETFs throughout the day vs. mutual fund orders that will be executed at some unknown price at the end of the day. In addition, you can also use online alert services to let you know when your positions hit specific dollar levels which will free you from staring at your holdings throughout the day, every day. Finally, the Pension Protection Act of 2006 has also opened the door for plan participants to access independent, third party 401k investment advice. Some plans have already included the provision that such advice can be paid (with pre-tax dollars) from the participant’s account.

Clearly every plan participant will be different in their risk tolerance and investment temperament; but, I believe the Self Directed Brokerage Account is a healthy step for plan participants to escape the commoditization of retirement investment choices.