How a Self-Directed 401(k) Could Save Your Retirement

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In the constant struggle to save for your retirement, a 401(k) plan can be your most valuable asset. But a 401(k) is only as good as the investment choices your plan offers. With a self-directed 401(k), you can turn the tables on the restrictive menus that so many employers have and choose the investments you want to help you retire comfortably.

Why you need a self-directed 401(k)
The vast majority of 401(k) plans don't offer a self-directed option. Instead, they typically rely on mutual funds, which give workers an easy way to get diversified exposure to different types of stocks, bonds, and other investments even if they only make small contributions from every paycheck.

There's nothing inherently wrong with mutual funds. What is problematic, though, is when employers don't give their employees the best mutual fund choices available. By locking workers into unfavorable funds, employers can end up sabotaging their workers' retirement prospects -- even as they think they're supporting their workers. By contrast, if your employer offers a self-directed 401(k) option for its workers, then it leaves the door open to your finding better investments on your own.

Dealing with duds
Last year, Morningstar took a look at 30 fund families. It ranked them on a number of factors, including performance, manager experience, and how much of their own money fund managers invest within the fund family. The results were revealing, as no-load managers Dodge & Cox and T. Rowe Price (Nasdaq: TROW  ) finished at the top of the list. Near the bottom, on the other hand, were AllianceBernstein (NYSE: AB  ) , BlackRock (NYSE: BLK  ) , and Hartford Financial (NYSE: HIG  ) .

Unfortunately, not all employers have the investment expertise to be able to tell whether one company's funds are better than another's. As a result, your employer may consider other factors, such as the employer's own administrative costs in managing your 401(k) plan, rather than focusing on giving you the best alternatives.

That's why a self-directed 401(k) option can actually be the best of both worlds. By turning responsibility over to workers to come up with their own investment choices, employers don't have to spend a lot of time figuring out which options are the best ones to include in their 401(k) plans. At the same time, employees don't have to constantly lobby for different fund options, which can be especially difficult if a fund family that used to be strong suddenly loses its way.

How self-directed 401(k)s work
Having a self-directed 401(k) option is almost like having a separate brokerage account within your 401(k). With it, you can buy any number of different investments, including stocks, bonds, exchange-traded funds, mutual funds, and in some cases even more specialized investments like real estate or precious metals.

With most self-directed 401(k)s, you'll end up paying a commission every time you make a trade. That's often a big contrast to regular 401(k) investment options, many of which don't charge you any upfront commission at all. But when you look more closely at the fees that various mutual funds charge, you may well end up paying less over the long run by using a self-directed 401(k) to invest rather than sticking with the default fund choices your plan offers.

How to get a self-directed 401(k)
Unfortunately, unless you're self-employed and can set up your own plan, it's not up to you whether you can have a self-directed 401(k). You'll have to ask your HR representative whether your employer would be willing to consider adding a self-directed option to an existing plan.

Given what's at stake, though, asking about a self-directed 401(k) is well worth the effort. You have nothing to lose, and if your employer agrees, it could give you the flexibility you need to invest a lot more successfully for your retirement.

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Fool contributor Dan Caplinger is very happy about his self-directed 401(k) options. You can follow him on Twitter @DanCaplinger. He doesn't own shares of the companies mentioned in this article. Motley Fool newsletter services have recommended buying shares of BlackRock. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy helps you save.

Read/Post Comments (2) | Recommend This Article (9)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On October 17, 2013, at 2:01 PM, MJackson123 wrote:

    It really is hard to tell a company what they want to be invested in with their 401k but if you have any control over it there is a lot you can do with a self directed 401k. Like you said you can invest in a lot of alternative investments. If your curious about how to invest your 401k into an actual business take a look at this cool image that lays it out.

  • Report this Comment On January 10, 2015, at 2:07 PM, andrewhar wrote:

    The way you begin this self directed option is by requesting it through your HR department. Many plans have this option nowadays. Simply ask them for an Enrollment Form for the Self Directed Brokerage Account. Many plans use a single outside company (such as TD Ameritrade). The Enrollment Form is only a few pages of basic information. Once opened, you'll be able to purchase the funds of your choice (preferably low cost index mutual funds from a Vanguard type, in my humble opinion). This article did not mention the reason that you want to do this - FEES inside your 403b or 401k plans are insanely high! Typically, they're 1-2% in some cases, compared to .18% like Vanguard!!! Do the math and you'll see why it's worth the effort. Best of luck.

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Dan Caplinger

Dan Caplinger has been a contract writer for the Motley Fool since 2006. As the Fool's Director of Investment Planning, Dan oversees much of the personal-finance and investment-planning content published daily on With a background as an estate-planning attorney and independent financial consultant, Dan's articles are based on more than 20 years of experience from all angles of the financial world.

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