401k Plans: Manage Your Own?
Strategic Finance Magazine On self
directed retirement plans for Strategic Finance magazine
Manage your own retirement plan
1 July 1999
EMPLOYEES LIKE SELF-DIRECTED 401(K) PLANS, BUT EMPLOYERS ARE CONCERNED ABOUT
The best way to make money is to do it yourself. On the other hand, the best way
to lose money is to do it yourself. Many people believe if they can manage their
own retirement accounts, they can become millionaires. It's not as easy as it
According to latest U.S. Department of Labor estimates, 65 million Americans are
currently eligible to participate in 401(k) plans, and this number is rising.
Employees like putting money away for retirement through a 401(k) plan,
especially with an employer's partial match. But many employees aren't very
happy with their plans because they offer only a meager group of investment
choices: a stock fund, a bond fund, the employer's stock, and a money market
In today's environment, with so many of us talking about how well our
investments are doing, such a limited choice of investment options doesn't sit
well. Many participants want more freedom, and that means more choices. They
want to choose investments rather than accept their employer's options. In
response to this development, an increasing number of 401(k) plan sponsors are
giving their participants what they want-a self-directed brokerage account
(SDBA). An SDBA allows an employee to choose any eligible investment and to
trade it at any time, through a broker.
David Wray, president of the 401 (k)/Profit Sharing Council, an educational and
training organization based in Chicago, says the self-directed brokerage option
is now offered by 9.4% of the plans surveyed in 1997, up from 4.4% in 1990.
According to Smart Money magazine, however, only nine companies out of the 96
largest 401(k)s have a self-directed brokerage option. The nine are Hilton
Hotels, PepsiCo, Chevron, Amoco, Sears, Tricon Global Restaurants, United Parcel
Service, Walgreen, and Xerox.
Many employers have decided to take the SDBA approach because of the insatiable
demand by plan participants for new funds. Plan sponsors, according to Wray,
"figure it's easier to offer a self-directed brokerage option than it is to keep
adding new funds to the menu of investment choices offered to plan
Mary Willett, director of supplemental retirement plans for the state of
Wisconsin, shares this view. Willett explains that the Wisconsin plan for state
and local government employees is broad based-it offers 13 investment options.
Each investment option has been evaluated by the state and found suitable. But
participants keep asking for more investment choices. Says Willett, "Many of the
funds that some of our participants want to invest in are high-risk investments
that aren't suitable for most employees. So to make such funds available without
`cluttering up the core,' our board has tentatively selected Charles Schwab to
offer a self-directed brokerage option to employees who aren't satisfied with
our core program. We are still working out all the contract details."
Bruce Fenton is the president of Atlantic Financial investment firm, an
Internet-based supermarket of financial products (http://www.af.com). He says,
"401 (k) plans that allow participants to have a Self-Directed Brokerage Account
(SDBA) are definitely on the rise." As Fenton describes it, "With some SDBA
plans, the participant feels as if he's got an IRA Account-the investment
choices are almost unlimited."
An SDBA is a powerful tool in the hands of employers trying to attract and
retain good people by offering plan participants greater investment flexibility,
enhancing the attractiveness of already popular 401(k) retirement plans. An SDBA
plan gives more experienced 401(k) participants "a way to diversify within their
401(k) plan," said David Peckman in describing the "Personal Choice Retirement
Account" offered by Charles Schwab and Company. Peckman is president of San
Francisco based 401(k) Forum, which bills itself as "The first online investment
advisor serving the needs of 401(k) participants." It can be found on the
Internet at www.401kforum.com/.
Fees for individual participants in Schwab's SDBA average around $200 the first
year and about $100 in subsequent years.
Employers offering an SDBA typically require plan participants who elect to
exercise this option to pay whatever added costs are associated with it. Says
Fenton, "That way, employees who don't want an SDBA don't have to shoulder the
expenses of employees that do:' Some employers who offer SDBAs limit the number
of mutual funds participants can invest in. Ditto for listed stocks and bonds.
Profits aren't guaranteed. In 1995, the 401(k)/Profit Sharing Council reported
self-directed brokerage accounts underperformed the S&P 500 on average by more
Many employers are concerned about offering too much freedom to their plan
participants. They don't want their employees making highly speculative
investments in their 401(k) plans. Their attitude is something like: "I'm
providing you with a 401 (k) plan to help you fund your retirement, not to do
day trading:" If an employee invests his/her entire 401(k) account balance in a
speculative stock that takes a steep nosedive, it's a public relations disaster
for the employer and a financial disaster for the employee.
William J. Metzer, CEO of Assets Unlimited, Inc., in Campbell, Calif., warns
against trying to actively beat the market or outsmart professional mutual fund
managers. "You would not try to remove your own appendix. Why try to invest your
own retirement money?" Still, about 30% of his customers use some form of
self-directed accounts. Technology makes it easy to have self-directed accounts,
but it doesn't make investors more market savvy. Computers don't ask Why?"
Participants can be attached to a stock or put all their investment eggs in one
basket, ignoring the benefits of asset allocation, according to Metzer.
As plan sponsors increase the number of investment options available, many plan
administrators are also offering their participants basic investment education
programs to help them make sound investment decisions. A recent survey found
that some 75% of 262 mid-sized and large companies polled currently provide
investment education programs to workers-up from 44% in 1993.
Laura Jacobs, Certified Financial Planner for Waddell & Reed in Santa Clara,
Calif., believes self-directed accounts will have a big impact on 401(k) plans
over the next several years. The rising stock market over the last five years
seemed to make it easy to invest safely. She points out participants need to be
educated and work with a good planner or broker to help them during the rough
times. These would-be investors must develop the self-discipline not to panic
during market downturns that inevitably will occur. For many, the best strategy
for 401(k) retirement accounts is still buy and hold.
Many 401(k) plan participants enjoy receiving a "menu" of mutual funds and other
investment options that come with the SDBA option, but some don't. Some
employees can find investing for retirement quite confusing and long for the
simplicity of bygone days when employers handled all retirement investments and
offered their employees a pension that was based on length of service and
average salary. Unfortunately, those days are gone. The size of an employee's
retirement fund will mostly depend on what investment decisions were made during
his/her working years.
Plan participants who lack the investment expertise to use the varied menus that
come with the SDBA option may be candidates for the 401(k) "Wrap" account. A
Wrap account is a brokerage account with a twist. The account holder pays an
annual fee that covers everything: investment advisory services, portfolio
management, advice on selecting other investment advisors, and the execution of
all client transactions. The annual fee paid to the brokerage firm is a
percentage of assets in the account. It can range from 1.5% to 3%. Mutual fund
Wrap accounts, for individuals whose portfolio consists of mutual funds only,
are rapidly gaining in popularity. The broker helps select an advisor to manage
the mutual fund Wrap account. The advisor evaluates the client's financial goals
and risk tolerance and then selects an appropriate mix of mutual funds for the
client. One fee covers all services provided within a mutual fund Wrap account.
A recent report on such accounts by Cerulli Associates, a Boston investment
consulting firm, says that mutual fund Wrap account assets make up 11% of total
Wrap assets under management, with $12.4 billion of assets. Cerulli estimates
that there are $117 billion of traditional Wrap account assets under management.
SalomonSmithBarney (SSB) is a major player in the 401 (k) Wrap business. SSB has
aggressively marketed its mutual fund Wrap programs, especially one called TRAK,
to 401(k) plan sponsors offering an SDBA option. TRAK offers participants access
to 14 strategically selected investment portfolios that encompass a wide range
of investment styles. Professional money managers, who may ordinarily serve only
institutional investors with deep pockets, manage the 14 portfolios. This may
suit the universe of 401(k) plan participants who lack investment savvy. SSB
also offers a Wrap program that employs no-load mutual funds. The fees charged
range from 1% all the way down to 20 basis points, depending on the number of
plan participants and funds to be invested. Both Wells Fargo and Prudential also
are major players in the 401(k) Wrap program market.
Tom Greeves, a Certified Financial Planner with Windsor Asset Management in
Bethesda, Md., says "High fees are a potential stumbling block for 401(k) Wrap
programs, but, for my money, I'd rather pay a high fee than make 'dumb'
investment decisions on my own." Gary Pittsford, an advisor with Crosspoint
Consulting in Indianapolis, Ind., agrees. Pittsford says, "Fees are coming down
for Wrap accounts-and that's good. But for an investor in a 401(k) plan who
lacks investment expertise, investing without advice isn't good. The 401(k) plan
participant should look for the best deal he can find, but investing without
professional advice is dumb." Terri Balding, a Certified Financial Planner with
Harbour Investments in Madison, Wis., observes, "Every investor needs an
investment program tailored to his needs. The `one-size fits-all approach'
doesn't work. You need advice." Wrap accounts can provide the vast majority of
401(k) plan participants with sound professional advice that will enable them to
invest wisely and save for a comfortable retirement.
Cost is the primary concern for plans offering the SDBA option. Offering
participants the SDBA option will increase plan sponsor expenses. According to
Fenton, "The least expensive plans are those with few bells and whistles. A plan
that offers the SDBA option has to cost the plan sponsor more." One way around
this potential deterrent is to require plan participants who elect to use the
SDBA to shoulder the full cost. Fenton says, "There has been little resistance
from employees to this approach. Employees recognize that they've got to pay to
Many administrative costs and problems will be reduced as interest increases and
technology improves. Most participants cannot obtain higher returns on average
than with a good mutual fund manager. Self-directed plans can be more expensive
and time-consuming to administer for both participants and plan sponsors.
Nevertheless, don't count them out of the market.
Gregg Rose is a Silicon Valley-based financial analyst with a background in
investment performance analysis, compliance auditing, incentive compensation,
and employee benefits. He can be reached by phone at 415-974-9804 or via e-mail
at [email protected] com.
Contributor: Milton Zall is a freelance writer based in Silver Spring, Md., who
specializes in taxes, investments, and business issues. He is a Certified
Internal Auditor and a Registered Investment Advisor. He can be reached by phone
at 301- 649-6044 or via e-mail at [email protected]
Copyright (c) 1999 Bell & Howell Information and Learning Company. All rights
written by Gregg Rose
Strategic Finance, Volume 81, Issue 1