Have More 401k Control with a Self-Directed Brokerage Window

Do you ever have the feeling that your retirement assets are jailed in your 401k account, or that your selection of mutual funds, individual stocks, or other investment vehicles does not exactly fit your needs? You're not alone. Increasingly, 401k sponsors are using their client's accounts to drive more retirement savings to their own in-house mutual funds. While this may be a boon for the 401k sponsor, it's a bust for retirees.

The Employee Retirement Income Security Act (ERISA) was designed to provide employees with better choices for their retirement plans, as well as help regulate the financial planning and retirement business that was, before the legislation, often as clear as mud.

One of the biggest changes with the passage of the ERISA, and subsequent legislation, is the amount of options that must be offered to employees by their employer. Under the law, at least three well diversified vehicles must be offered with their goals clearly stated. Subsequently, even in the barest 401k programs, investors often have a choice between conservative, moderate, and aggressive funds.

After the passage of new regulations, financial planners and 401k sponsors found that they could significantly reduce the amount of products offered to investors if they opened up what is known as a “self-directed brokerage window.” This self-directed brokerage window is appropriately named a window, allowing employees to have a window through which they can invest in any product imaginable – all through their employee sponsored retirement account.

401ks with Self-Directed Brokerage Windows


The self-directed brokerage window is an open ended offer by a 401k sponsor to allow investors the opportunity to purchase any stock, bond, mutual fund, or exchange-traded fund with funds already invested in their 401k. The self-directed brokerage window is also commonly referred to as a self-directed brokerage account, or SDBA on a 401k prospectus or solicitation.

The self-directed brokerage window was a product of the roaring stock markets of the 1990s, where investors began to demand more oversight on how their funds were invested and have direct access to the markets. As the 1990s turned into the 2000s, the explosion in internet access and online trading made the self-directed brokerage account more than just a way to skirt regulation, but a way to draw active clients to a 401k.

Today, more than one-fourth of all 401ks now offer the flexibility of a self-directed brokerage account, making less expensive and better diversified investments available with the flip of a switch. Also, as a side benefit, 401k sponsors are now reducing their own in-house fees and expanding their own options to compete with the window of opportunity that awaits through a brokerage window.

Self-Directed Brokerage Windows and Fees


Accessing a self-directed brokerage window does usually come with added costs. Most brokers offer the self-directed brokerage window for a flat cost of anywhere from $100-150 per year plus commissions, which at traditional brokerage firms can cost up to $20 per transaction or $40 round-trip.

While this access may seem costly, a self-directed brokerage account actually saves investors money in the long-run, and for wealthier 401k savers, allows for a huge reduction in expense ratios with the proper use of exchange-traded funds.

Self-Directed Brokerage Account Strategy


It's unlikely that you'll be day trading any time soon with your 401k or gambling hundreds of thousands of dollars on the futures markets. You might, however, find that by using your open access brokerage window, even at a cost of $150 per year, you can save hundreds of dollars on fees and greatly increase your total expected retirement savings.

401k plans are notorious for carrying the most expensive mutual fund options available, nickel-and-diming retirement savers, who thanks to an employee contribution, are unwilling to pass up a full investment into their 401k. With the high cost of accessing a self-directed brokerage account, it is important to consider your strategy in reducing your expenditures and increasing your account performance.

It is likely that your current 401k offerings consist of fund of funds or mutual funds which hold other mutual funds. All told, these products generally cost at least 2% per year, most of which comes from the high fees hidden in the mutual funds held in the fund of funds. On a $10,000 401k account, that comes out to a whopping $200 per year. For $100,000 in savings, that's a massive $2,000 per year in fees. Surely, there is a better way.

Exchange-traded funds that trade on the stock exchange cost as little as .25% per year. However, due to the fact they trade like stocks, investors incur commissions for each buy and sell order. Thus, the low fees, at least for some, are negated by their significantly higher commission costs. Mutual funds, of course, are almost always free to purchase through a 401k.

To buy into five exchange-traded funds twice per month will generate 10 different transactions, each costing up to $20 each. In one year, an investor would spend some $5200 on trading commissions through a self-directed brokerage account. For most, that's a money loser.

However, what many fail to consider is the restructuring allowed within your core 401k holdings at any time. Often, a fund company offers investors the ability to buy or sell their mutual fund holdings within their ETF at their pleasing – and with no fees, as long as the funds have neither a front-end or back-end load.

Thus, most investors, once per year, quarter, or whatever time is most preferable, can exchange their mutual funds for exchange-traded funds. The sale of mutual funds costs nothing, and the purchase of exchange-traded funds costs $20 each. Thus, to sell five mutual funds for exchange-traded funds would cost at the most $100 in commissions, plus $150 to access the broker window per year. All told, an investor would pay just $250 per year to swap their free to purchase mutual funds for exchange-traded funds.

Considering the difference between mutual fund fees often starts at .75% per year, an investor would need have only $33,000 in retirement savings to see a difference in costs their very first year. Each subsequent year, the savings would only continue to grow.

The best time to open a self-directed brokerage window or self-directed brokerage account is immediately. The difference between $10,000 in exchange-traded funds self-directed brokerage window earning 8% and $100,000 in mutual funds earning 7.25% is an incredible $19,000.
Tim Ord
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