But instead, most of us get a menu of mutual funds that our employer has chosen for us. Many of the people who decide what goes into their colleagues’ plan do a great job. Others, however well-meaning they may be, end up selecting expensive, mediocre investments.
Over the last couple of months, I’ve outlined the case for putting low-cost index funds in workplace retirement plans and chronicled one man’s epic, decade-long quest to improve his small company’s investment lineup.
But there is another, potentially faster way to improve a plan, one that puts within reach the fantasy of choosing nearly any investment you desire. Your employer can simply add something called a self-directed option, also known as a brokerage or mutual fund window. At that point, your 401(k) or similar account becomes like a regular brokerage account, where you can buy any mutual or exchange-traded fund (and in some cases, any individual stock) you want.
For many years, doctors, law firms and other white-collar professionals have been prying open the brokerage window in their own plans. Elsewhere, however, paternalism has generally reigned, with employers worrying about people piling into speculative stocks.
“They said it was like putting a loaded gun in someone’s hand, and that people would trade away their life savings,” said Robert Jesch, the managing director at Charles Schwab who oversees the company’s self-directed brokerage offering.
In fact, this is not what happens most of the time. So let’s review, one by one, the objections your employer may raise — and knock them all down.
TOO MUCH TRADING Buying and selling too often tends to hurt returns, both because of the commissions you usually pay and because of investors’ tendency to pile in when prices are high and retreat when things look grim.
Schwab tracks the average number of trades each year in the self-directed part of its workplace retirement plans. And while the number has risen steadily over the last five years, it was only 5.2 in 2010.
That suggests the counterintuitive possibility that some people may not be trading enough. As Steve Utkus, who runs the Center for Retirement Research at Vanguard, notes, you have to purchase investments in the first place. If you wait too long, the low returns on cash can create a drag on returns.
Also, for what it’s worth, a 2007 Vanguard study found that once it adjusted for differing risks depending on the mix of investments in people’s accounts, active traders in retirement accounts achieved returns that were statistically similar to those of people who didn’t trade at all.
I’m not advocating active trading or messing around with individual stocks. The goal is to get yourself into something better than what your employer now offers on your fund menu. This means buying ultra low-cost mutual or exchange-traded funds that track segments of the market that your employer doesn’t give you access to.
THE WRONG INVESTMENTS Even so, employers will still fret. Veterans of the 401(k) world remember the frustration workers expressed when they couldn’t invest in Cisco and Pets.com. In retrospect, piling in at that moment wouldn’t have worked out so well.
If your employer wants to keep some protections in place, it can close off the possibility of investing in individual stocks and other securities in a retirement plan brokerage window.
They can also place a cap — say 50 percent — on the percentage of your retirement account that you’re allowed to invest through the self-directed option.
BrightScope, a company that tracks and ranks 401(k) plans, searched employers that reported enough data to the federal government that BrightScope could track the percentage of employee retirement funds in the self-directed option. In 2009, the bankers and brokers at the financial services firm Morgan Keegan Company had 81 percent of their funds in the self-directed option. Some law firms were also above 50 percent.
Many of these employees are financial experts, so perhaps they don’t need a cap. But if your employer wants one as a condition of opening the brokerage window, then you can probably live with this if there are at least some decent investment options on your plan’s standard fund menu.
HIGH FEES Fees in a self-directed option can come in two main forms, a fee for regular account maintenance and a per-trade fee.
Some investors will pay nothing. Others may pay annual fees of $50 to $100 but no commissions on trades for certain investments. Or you may pay no annual fee but pay $5 to $10 for most trades and get hit with larger fees for buying certain funds.
If you don’t have much money saved, these fees can make this option uneconomical. If your balance is $10,000, $200 in annual and trading fees each year represents a vaporization of 2 percent of your money.
An employer may be able to shield you from some of this by negotiating away annual fees or covering them for you. And you can keep trading costs reasonably low by using the brokerage window only for things like small doses of real estate, commodity funds or other more basic things that are part of a well-balanced investment plan but may not be part of your employer’s core offering.
Twitter: @ronlieber
Article source: http://feeds.nytimes.com/click.phdo?i=bb56b0d4a23ed4ea8b3d546b3cfb77f9
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