Is a Self Directed 401k Better than the Main Menu Investment Options?

This article will address the potential benefit of moving assets off the 401k main menu into a self directed 401k sub-account.

Few employers offer a 401k which includes a self directed brokerage account. If you participate in such a plan then you may want to look a little deeper into just what investment options are available through this channel. The primary reason that this option has grown recently is the Pension Protection Act of 2006. This Law includes a provision directing plan providers (the vendor who offers your employer the 401k platform) to offer plan sponsors (your employer) this plan feature to plan participants (you). The intent of the self directed 401k is to lessen the potential conflict of interest on the part of plan providers to offer proprietary funds or funds from companies with whom they have a financial interest.

This is not to say that all plans that have a self directed option are this open. In fact, I have seen a Fortune 500 company plan were the plan participants were only offered an additional 300 mutual funds. You can imagine how many plan participants have elected to leave the main menu in this situation. Clearly the only one benefiting is the Wall Street Brokerage Firm that is the Plan Provider. Would you be surprised to learn that this plan provider was one that blew up during the liquidity crisis?

Anyway, to the extent that your employer has elected to offer this option with no more restriction on investment selection as required by law (basically the same as an IRA account), then you have an opportunity to improve your returns. All things being equal, you will be able to invest in lower cost and therefore better performing exchange traded funds (ETFs). The benefit of diversification is the same as mutual funds with the added benefit of being to buy and sell at know prices during the trading day.

Through the self directed 401k as described above, you will be better able to execute a global tactical asset allocation. Using ETFs you can diversify across most every asset class to construct a dynamic investment portfolio that should perform better than a vanilla 401k main menu of 7 to 10 mutual funds.

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