Regardless of what type of 401 (k) plan you have, you are responsible for your investments even if your choices are limited to a short selection of mutual funds. Of course, with a mutual fund, you have no control over which securities are bought and sold.
Even if you have a lot of choices for your 401 (k), you can seek the advice of a financial advisor to help you decide where to invest your money. That helps, but even with an advisor, you're still limited to your company's menu of choices. And then, of course, there is the fact that professional fund managers regularly underperform the market.
All this increases the temptation for those who are smart in the market way – you perhaps? – Choose the self-directed or brokerage window option of their own 401 (k) plan and take over the administration of their plan 401 (k) themselves. (For more information, see The Rise of 401 (k) Brokerage Accounts .) If your company's plan has this feature, you should select it?
Pros
There are several important factors that could push you in a do-it-yourself direction.
More choice. With a self-directed plan you have much more investment decisions. In addition to mutual funds, you can include exchange traded funds (ETFs), individual stocks, bonds and even non-traditional options such as real estate in your portfolio.
"If you go the self-directed route, you're no longer tied to your 401 (k) plan's 15-18 set investment options," says John P. Daly, CFP®, president, Daly Investment Management, LLC, in Mount Prospect, Ill. "You can buy almost any stock, ETF or mutual fund on the custodian's platform. This can be very useful, especially if your plan has limited investment options or low-quality investment options. "
Quality. Instead of a limited number of mutual funds (some of which may be poorly selected), a brokerage window offers a wider range of options, so you are more discriminating.
Experience. If you have investing knowledge and skills, you can leverage them by managing your own investments. This can be a real plus, considering the limited number of options a traditional 401 (k) typically offers.
Discipline. If you are a disciplined investor and don't need to invest on a whim or panic, you can take better advantage of the opportunities available in a self-directed 401 (k) than in a fund managed by someone else. (For more information, see The Importance of Trading Psychology and Discipline .)
Not – Traditional Investment Options. With a self-directed 401 (k), you can consider real estate and other nontraditional investments that could potentially offer exceptional earnings opportunities.These options are not available to ordinary 401 (k) investors.
Cons
There is, of course, a downside to making your own investments.
Rules. Along with the variety of options you have under a self-directed 401 (k) option come IRS regulations that exclude you from certain types of investments. If you are not aware of these regulations, you could be in trouble. (For more information, see 5 investments you can't hold in an IRA/qualified plan.)
Fees. Fees tend to be higher for most investors who manage their own investments outside of mutual funds. If you trade too often, the fees associated with trading can wipe out most, if not all, of your gains.
Novices Watch out. Even if you understand your options well, a lack of experience can cause you to miss nuances that managers or financial advisors don't have. If things go south, there will be no one to blame but yourself. Remember: there are no mulligans in investing. (For more information, see: 10 Golf Tips That Help Investors Dance Off .)
"The biggest bonus to a self-directed option is the ability to manage expense ratios within each individual investment." says David S. Hunter, CFP®, President of Horizons Wealth Management, Inc. in Asheville, NC "However, this opens up thousands of investment opportunities and there is always the possibility that an investor will be hamstrung by options and may not be able to participate. as much as you would with a set-it-and-forget-it 401 (k) plan. "
Research. Know-how and discipline aside, investing takes time. Make sure you have enough of them to keep up with financial news and what you need to know about companies you want to invest in.
Lack of liquidity / transparency. Some of these non-traditional investments you now have access to lack transparency and liquidity. This means you may not be able to get in and out as quickly as you would like, and you may have difficulty gaining a clear understanding of your position – unlike stocks and bonds.
"The downside of managing your own 401 (k), beyond the additional fees, is that you potentially become your own worst enemy," says Mark Hebner, founder and president of Index Fund Advisors, Inc. in Irvine, Calif. and author of "Index Funds: The 12-Step Recovery Program for Active Investors."Many investors who do not work with a professional investment advisor often let short-term market movements dictate their long-term investment strategy. Cause disastrous long-term effects in very turbulent times. "
Self-directed 401 (k) vs. self-directed IRA
In addition to the self-directed 401 (k), the IRS also offers the option of an IRA itself. The advantages and disadvantages are similar: one main difference is the contribution limit: it is higher for a self-directed 401 (k).
In addition, self-organized 401 (k) plans allow for loans. It is possible to obtain loans with a self-directed IRA, but they are much more difficult to obtain.Finally, you don't have to hire an administrator for a self-directed 401 (k). However, IRAs will need a trustee. (For more information, see Self-Directed IRA: The Right Approach for You? )
The final result
A look at the advantages and disadvantages listed above makes it clear that you need to manage your own investments. For the faint of heart. It is also not for the uninformed. It's also not too busy for anyone to do real research.
"Although managing your self-directed 401 (k) seems like a great idea, the lack of research and professional advice, along with other potential obstacles like higher fees, lack of transparency, and complex IRS rules, can become a problem. "Says Carlos Dias Jr., Founder and wealth manager of Excel Tax & Wealth Group in Lake Mary, Fla.
Knowing yourself is your tolerance for risk, your knowledge of investing and your ability to maintain composure and discipline. If you decide to go it alone, learn about the tools available to help you manage your own investments. For an in-depth look, read Investopedia tutorial Become Your Own Financial Advisor .