Planning Your Financial Future
What the Heck is a Self-Directed Brokerage Account and Why Should You Consider It?

The good news is that some firms offers a self-directed brokerage account to its 401(k) participants. The problem is that not many people really understand what it is or why they might want to use this feature.  Let’s start with the basics:

 What is it? A 401(k) self-directed brokerage account allows participants to make investments outside of their regular plan window. So rather than investing in a limited number of options offered within the plan, a self-directed brokerage account often includes many more investments like stocks, bonds, mutual funds, and ETFs.

Why do participants use it? Over time, highly compensated employees can potentially save millions in their 401k accounts. When retirement account balances grow larger, participants may want the flexibility and choice that self-directed brokerage accounts offer. They are a good option for those who want more diversified investment strategies or would like to have their financial advisor advise on and manage these assets.

Why do we recommend this option for some participants? Gaining access to thousands of stocks, mutual funds, or ETFs allows participants to allocate their assets over a potentially wider array of investment options like alternatives, hedged equity and real estate that may not be available within their retirement plan. Holding many of these alternative or tax-inefficient investments in a self-directed brokerage account, rather than a taxable account, may reduce their annual tax bill.

I explain how this works in my article: The Best Way to Minimize Taxes With Asset Location.

Who should stay away from self-directed brokerage accounts? Self-directed brokerage accounts are not for all companies or all employees. Employer retirement plans work well because of the strict rules and extensive due diligence done by plan sponsors. Plans typically provide a limited number of options to simplify a participant’s choices while trying to eliminate the confusion that often comes with having too many investment options. If you’re not a sophisticated investor, don’t have the time to do proper research or don’t plan to get professional investment advice, you may want to steer clear of this option.

Self directed brokerage accounts are not for everyone but it’s important that each individual understands the pros, cons, opportunities and fees of their 401k options.