Since their introduction in the 1980s, 401(k) plans have evolved. The early plans offered just a few investment choices. Then companies began offering dozens of mutual funds from which to choose. Now, in large employers, one trend is to operate a 401(k) on two tracks. The first typically contains a menu of age-based, target-date funds and other mutual funds covering most asset classes. The other is a "brokerage window," or self-directed 401(k), for people who want more control over how their retirement nest egg is invested.
A self-directed 401(k) allows you to invest part of your account in individual stocks, mutual funds or other investments that you select outside of the dozen or so mutual funds in the typical plan menu. Your employer decides whether your plan will offer a brokerage window and how much you can invest through it. Your employer can also determine the range of allowed investments. Some may restrict you to mutual funds, while others might allow a broader range of choices, including individual stocks and specialty funds.
Big companies have added the self-directed option as they've cut the number of mutual funds in their plans. About 30 percent of large and midsize employers offered brokerage windows in 2011, according to benefits consulting firm Aon Hewitt. But even among the companies that offer a self-directed option, your typical investor isn't using it. The Vanguard Group reports 23 percent of their 401(k) participants are offered a brokerage window but only 1 percent use it. Fidelity Investments has a similar ratio, reporting 38 percent of its participants have access to a window but only 2.4 percent use one.
Going It Alone
You might think young adults are the ones investing their 401(k) money themselves, betting they can beat the market. But older investors with larger balances are more likely to use the self-directed option than younger ones. Half of the self-directed 401(k) investors at Charles Schwab are over 50. Typical brokerage window users have about $200,000 in their 401(k) plans, about three times the average balance. Men are also more likely to take the self-directed route than women.
A self-directed 401(k) can hit you with a yearly fee of $50 to $100. While there are typically no transaction fees for buying and selling in a regular 401(k), each purchase and sale through a brokerage window can cost you in commissions. If you want to keep costs and risk down, you may opt to keep some of your assets in conservative core holdings like index funds in a regular 401(k) and a percentage in the self-directed option. You can minimize trading to help keep your expenses down.
Dyanne Weiss has more than 20 years experience in human resources and corporate communications. Her communications strategies' have aided employee engagement and understanding of health care benefits, retirement planning, performance planning and compensation. Weiss has also worked in several industries: energy, insurance, banking, financial planning and health care. She has an MBA in management and organizational behavior.