Using 'brokerage window' to expand 401(k) options

Do you trust your investment prowess enough to put your 401(k) plan on the line?

Don Uphouse, chief finance officer of Active Minerals International in Sparks, Md., does. The 59-year-old uses his company’s brokerage window as a way to save and invest for retirement.

“I’m a seasoned investor, and I enjoy picking my own stocks,” said Uphouse, who says his customized portfolio of about 80 blue-chip stocks is up by 10 percent year-to-date, exclusive of his contributions.

The executive keeps an eye on his account every day, but limits transactions to one or two stock purchases a month. When investors fled equities in the aftermath of the 2008 recession, Uphouse says, he stayed put and bought more stocks.

Uphouse is among a handful of retirement plan participants who partake in their company’s brokerage window, a feature that offers a wider selection of individual stocks and mutual funds to employees who prefer a hands-on approach to investing.

A calculated risk

A small, but growing, number of employers overall offer brokerage windows, and an even tinier portion of employees use them.

At Vanguard, 7 percent of plans offered this feature in 2006, and last year that number increased to 16 percent. One out of 100 participants actually used these accounts.

“About 15 to 20 percent of our overall book of plans uses these, but 45 to 50 percent of the very large firms offer them,” said Phil Chisholm, vice president of product management at Fidelity.

“The large plans have a level of sophistication from an administrative standpoint,” he said. “They have educational programs and oversight that allows them to take that responsibility on.”

Who pays for a brokerage window will vary according to the situation. In plans when participants cover the cost of recordkeeping and administration, investors in the brokerage windows are also footing the bill for those expenses. Other times, a recordkeeper may assess a flat fee to the employer. That cost can be in the range of $1,500, said Aaron Pottichen, president of retirement services at CLS Partners in Austin, Texas.

Brokerage window investors tend to have more saved: They have an average balance of $338,000, according to Fidelity. In comparison, the average 401(k) plan account balance was $88,900 in the second quarter.

If you’re thinking about entering your retirement plan’s brokerage account, here are some risks to bear in mind.

Going off the menu

In recent years, employers have embraced simple core fund menus. Rather than giving employees dozens of investment options, companies might have about 20 mutual funds available to their participants.

“Plan sponsors were going with a streamlined lineup, and target date funds took off,” said Jania Stout, co-founder of Fiduciary Plan Advisors at HighTower in Owings Mills, Maryland. “Now, participants who want choices want a broader lineup,including brokerage.”

There are stark differences between the funds available to you in your 401(k) plan’s core menu and the investments in your brokerage window.

For instance, your employer has a fiduciary duty to select and monitor the funds in the core menu; there’s a measure of scrutiny and vetting involved.

This doesn’t apply to the brokerage window. There, you are left to your own devices to ensure that you choose the right combination of investments.

“When folks go into a brokerage window, they often construct very concentrated and risky portfolios,” said Ross Bremen, a partner atNEPC LLC, a Boston-based retirement plan consultancy.

Pricing will also vary.

Often, 401(k) investors who choose from the core fund menu can take advantage of lower costs, as they are pooling their plan assets to invest. Brokerage window investments are offered at a higher cost that retail investors would normally pay.

Legal and regulatory developments

It’s no secret that these are litigious times for plan sponsors, as employees allege they’re being charged excessive fees for funds,administrative services, and recordkeeping. Along those lines, some 401(k) advisors are encouraging plans to think twice about brokerage windows.

“Most participants aren’t going to make good choices, so I would rather not have them blow themselves up,” said Pottichen of CLS Partners. “From a liability standpoint, why give people an opportunity to hurt themselves?” he asked.

Further, the U.S. Department of Labor this summer proposed additional rules that will call for employers to provide more reporting on brokerage windows in retirement plans. That rule is currently in its comment period.

Ask yourself

Brokerage windows aren’t for everyone. If you go for this option, you’re taking a sizable risk.

Bremen of NEPC had the following suggestions:

  • Consider your investment expertise: Do you really have the know-how to make an informed decision from a wide range of choices?
  • Get ready to be engaged: There is no “set it and forget it” in the world of brokerage windows. You need to monitor your selections on an ongoing basis — especially if you’re picking stocks. “Tell me in the last 24 months, how many times have you logged in to look at your account,” said Stout of Fiduciary Plan Advisors. “If you logged in once or not at all, you’re not a good candidate for brokerage.”
  • Think about whether you really want to pay higher fees: Think about whether you want to pay retail fund fees, as opposed to the institutional fees in the core menu, said Bremen of NEPC. There are also annual brokerage window costs and trading fees to consider.
  • Be wary of trendy investments: Don’t chase the stock or fund du jour. Keep a long-term perspective with your investments.
  • Seek help: Talk to an advisor and make sure your investment model is sound. “It doesn’t hurt to run whatever strategy by a professional who lives and breathes this stuff every day,” said Stout. “You can get into a lot of trouble if you aren’t careful.”

Originally Published by Darla Mercado, CNBC

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly.

The information provided is not intended to be a substitute for specific individualized tax planning or legal advice. We suggest that you consult with a qualified tax or legal advisor.

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