Understanding Self-Directed Brokerage Accounts
A recent article published by the Wall Street Journal suggests more plan sponsors are adding self-directed brokerage accounts to their corporate retirement plans. But what exactly is a self-directed brokerage account, and is adding one to your plan a good idea?
Simply speaking, a self-directed brokerage account, or brokerage window, allows participants in a retirement plan to access a very wide array of investment options. Instead of being restricted to a specific menu of options (typically 15-25), participants can pick and choose from hundreds of available options.
The recent uptick in interest in brokerage windows appears to be linked to plan sponsors’ interest in down-sizing their investment menus. In general, as more companies look to simplify their 401(k) plan’s investment menu, some are adding a brokerage window at the recommendation of their platform provider to “appease” those few participants who might otherwise complain about fewer choices.
While seemingly benign on the surface, there are a number of potential drawbacks to consider before jumping on the self-directed brokerage account bandwagon:
1. Additional Costs - Most self-directed brokerage accounts charge a fixed per account fee on an annual basis. This fee ranges anywhere from $50-$200. Participants will also be subject to additional trading costs. Finally, the funds offered tend to have higher retail fund expense ratios, in comparison to the institutional options available within a large company plan menu.
2. Increased ERISA Fiduciary Exposure - It is impossible for plan fiduciaries to properly monitor all the investment options available in self-directed brokerage accounts. This leaves fiduciaries more vulnerable to 404(c) disclosure issues, prohibited transactions, and excessive fee complaints.
3. Low Utilization - According to Vanguard, plans offering self-directed brokerage accounts typically see 1-4% of participants utilizing this option. Most participants prefer a more hands-off, "do-it-for-me" approach. Such low utilization begs the question - Why go through so much trouble (and risk) to benefit so few?
Despite these drawbacks, brokerage windows are rising in popularity. We believe this popularity is largely driven by financial service providers that have a clear profit motive for recommending them.
In a world dominated by customization, self-directed brokerage accounts are a classic example of “more” not necessarily being “better.” Brokerage windows are an option for plan sponsors to consider, but their drawbacks often outweigh their benefits.