A 401(k) is vital for your retirement plan. Investing in a 401(k) is one of the most popular ways U.S. workers save up for their retirement. The tax advantages, automated contributions, and ease of investment make it a particularly financially valuable instrument. Moreover, if you start investing in a 401(k) from an early age, chances are you will be a millionaire by the time you retire, provided you maximize your contributions and invest your 401(k) funds wisely. Contributing to a 401(k) account is one step; the other crucial step is to invest your money prudently to maximize gains.
Generally, 401(k) plans offer a range of investments, but a single plan might not offer them altogether. The final choice of investments depends on your employer. Most employers give you an option to invest in mutual funds – stocks, bonds, target-date funds, stable value funds, etc. However, while opting for these investments is relatively easy, your options are highly restricted. This implies that you miss out on the opportunity to grow your funds tax-free. For instance, if you are a high-risk investor but you only have options to invest in a 401(k) that offers mutual funds rather than individual stocks investments or ETFs (Exchange Traded Funds), you are losing out on the opportunity to grow your tax-free wealth.
Limited investment options have always been a major drawback of the 401(k)-retirement savings plan. However, most people do not think of alternatives because they do not have a clear idea of how a 401(k) fund works. As per a recent survey, only 37% of Americans can define what a 401(k) is. And according to a recent poll from ValuePenguin, only a third of Americans fully understand how their 401(k) account works.
A method to overcome the limited investment option drawback is by opting for a Self-Directed Brokerage Account (SDBA) or a 401(k) brokerage window. This alternative account offers a wide choice of investment inside your 401(k), giving you an option to invest as per your risk appetite and not be limited by the available securities as selected by the employer. So, if you are an aggressive investor and can afford to take higher risks, then you have an option to choose more aggressive fund choices. As per Aon Hewitt, as many as 40% of the current 401(k) plans offer an SDBA. Despite the COVID-19 pandemic, the balance in these accounts continued to rise in 2020, contributing to a 9% increase year over year.
However, if you do not know how to invest your 401(k) in stocks, you are not alone. As per the Aon Hewitt survey findings, only 3% to 4% of the retirement participants that have access to the SDBA use the option. But if you aim to make full use of your 401(k) plan, you should understand how an SDBA works and see if it fits your purpose.
Here is everything you should know about how to invest your 401(k) in stocks:
401(k) plans came into effect in the 1980s after the virtual disappearance of the defined pension benefits. Over the years, these plans became a primary retirement savings vehicle for most retirees in the U.S. However, since their inception, 401(k) plans have offered only a limited palette of investment options to the employees. Some employers also offer more investment choices to ensure optimal diversification of 401(k) plans to oblige the rules and regulations of the Employee Retirement Income Security Act (ERISA). But most plans fall short. Many employees do not have information about these additional choices, and others do not opt for them because of a lack of input. Hence, an average retiree ends up within a limited menu offered by the employer.
But if you want to follow a different path and invest 401(k) in stocks, you can do that through an SDBA. Some employers have started offering self-directed brokerage accounts to employees in response to the increasing demand for wider investment options.
A self-directed brokerage account (SDBA), also known as a 401(k)-brokerage window, allows you to invest 401(k) in stocks. These accounts are held by the plan administrator, but all the investment choices and decisions are made by you. An SDBA serves as an alternative to the traditional mutual fund investments offered by the employer through your 401(k).
An SDBA allows you to treat your traditional 401(k) account like a typical brokerage account with access to a wide-ranging assortment of investment options. These plans allow you to invest in publicly traded securities, which are otherwise not on the menu of a general 401(k) plan. However, it is your responsibility to ensure that you invest as per your risk tolerance, financial situation, retirement goals, and time horizon. A self-directed brokerage account gives you interesting investment opportunities but only with a heightened risk of investing. You could access a greater menu of mutual funds or invest in individual stocks, bonds, ETFs, and others. Apart from this, you also get access to professional money management, allowing you to grow your funds through expert guidance. By investing in lucrative options outside the 401(k) core choices, you can aim to maximize your returns by choosing securities best suited as per your goals and risk preference.
By giving you access to an SDBA through your 401(k), your employer allows you to move your assets, tax-and penalty-free, into a brokerage account with a large selection of investment choices. However, your funds remain in the retirement plan and are not rolled over. Moreover, you continue to enjoy the same tax advantages as a traditional 401(k) account.
Even though investing via SDBA is tactical, you can maximize your returns and get professional guidance for money management if you are an avid investor. A self-brokerage account allows you to invest without emotional bias and enables you to make rational decisions based on professional advice. You can also hire a financial advisor to provide you with complete guidance on how to best use an SDBA and select the right assets to achieve your investment goals.
SDBAs follow the same rules and requirements as an ordinary 401(k) plan. It is good to know and understand the different IRS (Internal Revenue Service) rules governing SDBAs.
Here are some of the top reasons why you can consider investing 401(k) in stocks through self-brokerage accounts:
SDBA offers several critical advantages. But, these accounts also have their drawbacks. Here are some of the disadvantages you should know about investing through SDBA:
If you are the type of investor who constantly keeps track of the market and has better knowledge and time for portfolio management, you can opt for an SDBA 401(k). Moreover, if you desire more flexibility in investment and a wider assortment of investment securities, you can choose the SDBA. However, you must be careful to exercise caution due to the risk that comes along with wider access to investment securities.
The self-directed brokerage accounts will become significantly popular over the coming years because of the growing acceptance of active trading and the increasing risk appetite of investors. If you want to take advantage of the benefits of the SDBA but do not wish to or have the time for active management of your investment portfolio, consider engaging with a professional financial advisor. Vanguard reported that professional advice could potentially add 3% or more value to an average portfolio value. When compounded over time, 3% can make a huge difference to your retirement financial security. A professional financial advisor has expertise on the limitations of a SDBA and other retirement accounts.
To further understand how you can use your 401(k) to achieve your investment goals, visit Dash Investments or email me directly at email@example.com.About Dash Investments
Dash Investments is privately owned by Jonathan Dash and is an independent investment advisory firm, managing private client accounts for individuals and families across America. As a Registered Investment Advisor (RIA) firm with the SEC, they are fiduciaries who put clients’ interests ahead of everything else.
Dash Investments offers a full range of investment advisory and financial services, which are tailored to each client’s unique needs providing institutional-caliber money management services that are based upon a solid, proven research approach. In addition, each client receives comprehensive financial planning to ensure they are moving toward their financial goals.
CEO & Chief Investment Officer Jonathan Dash has been profiled by The Wall Street Journal, Barron’s, and CNBC as a leader in the investment industry with a track record of creating value for his firm’s clients.
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