Thursday, August 28, 2008

401k Freedom of Choice

“Oh freedom (freedom), freedom (freedom), freedom, yeah freedom
Freedom (freedom), freedom (freedom), freedom, ooh freedom”
- Think - performed by Aretha Franklin

Many (if not most) 401k plans offer a limited menu of investment choices. One would expect that larger employers would offer more choices, but there doesn’t seem to be any correlation between the size of the employer and the investment options offered in a 401k plan. Unfortunately, many employers do not offer what financial planners would call a sufficient range of investment options. A typical 401k plan offers a limited number of mutual funds, often funds from the same mutual fund family e.g., T. Rowe Price, Fidelity and others (not to pick on either of these firms). A newer trend in 401k plans is offering mutual funds from several different fund families and, while better than “single family” options, the choices are still often narrowly limited.

Enter, the Brokerage Window.

Recognizing the desire for more investment diversity and control, more employers are adding the ability to establish a brokerage account within their 401k plans. With a brokerage option in a 401k plan, employees have an almost unlimited choice of investment options. One can finally build a 401k account tailored to their individual risk tolerance without compromising based on a limited menu of investment choices.

If your employer is offering a brokerage account option for your 401k plan, sign up.

Now, just because you can buy (almost) anything doesn’t mean that you should. This is your retirement money, not your Vegas money (you've seen those ads - "What happens in Vegas, stays in Vegas"? they don't mention that mostly what "stays in Vegas" is your money...). Build an asset allocation plan tailored to your personal risk tolerance and stick to it (e-mail me - see below - for a self-scoring Risk Tolerance Questionnaire). Professional financial planners (such as yours truly) design asset allocation plans all the time. Seek out competent advice – paying a professional fee for an hour or two of work will be money well spent.

The brokerage account option should allow you to invest in Exchange-Traded Funds (ETFs). ETFs are in many ways superior to mutual funds – cost being one of the most desirable. The cost of ownership in the average mutual fund is ~1.35% vs. ~.41% for the average ETF (per CNN). Why is this important? Because returns always vary, but expenses go on and on. Given the exact same investment performance between the average mutual fund and the average ETF, the ETF will have a return that is nearly 1% higher because of the lower cost.

1. Sign up for your plan’s brokerage account option.

2. Design an asset allocation plan – with professional help if needed.

3. Implement the allocation plan using ETFs.

4. Relax. Enjoy life.


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