With Hurricane Sandy bearing down on New Jersey in 2012, Governor Chris Christie memorably took to the airwaves. “Get the hell off the beach!” he scolded the stragglers who did not take the storm threat seriously. I feel the same way about brokerage windows within 401(k) plans. They are risky, potentially very expensive and appropriate for only a very small fraction of 401(k) investors. Don’t offer them in your plan. Period. If a weather professional (think the great Jim Cantore) wants to stand in the middle of a hurricane, that’s his business. Everyone else – Get off the beach!
I’m a big believer in the power of markets. At first glance, my anti-brokerage window stance would seem like setting limits on free choice. But we are considering brokerage windows inside 401(k) plans – particularly small business retirement plans – that already offer appropriate investment offerings to allow participants to diversify their investments. If the plan investments are well chosen, brokerage windows are not needed. And if the investment selections are lacking, get new ones. Brokerage windows are not a substitute for due diligence!
Debunking the argument for free choice
I know the argument for brokerage accounts in retirement plans. Sophisticated investors want the choice to invest in whatever they want, whenever they want. By eliminating the brokerage option we are punishing the knowledgeable investor. Good philosophy, but poor logic. Allow me to retort.
The fiduciary responsibility model in 401k plans produces optimal results. When appropriately implemented, fiduciary standards work fine. Sponsors and fiduciary advisors quietly add value and help participants prepare for retirement. Brokerage windows undermine the fiduciary process and devalue the beneficial work done by fiduciaries. What seems like increased choice is actually a rejection of the fiduciary process. Bottom line: the increased choice often results in a net loss versus a fiduciary solution.
Brokerage window investing is appropriate for a microscopic portion of plan participants and toxic for everyone else. Only a tiny fraction of 401(k) investors have the financial experience and savvy to benefit from a brokerage window. I’ve been investing and advising for 30 years – and I would shy away from such an account. Too often, brokerage windows create an opportunity for uneducated investors to act on shoddy advice. In my experience, brokerage windows produce more tears than cheers.
Brokerage windows can be expensive. Within brokerage windows, transactions fees can add up. Think biweekly contributions of $700 going into a single investment. Even at $10 per trade that’s $260 in trading costs, or about 1.4% of contributions. Add additional investments and sell trades and the costs can go much higher.
Brokerage investments are impossible to monitor. Plan sponsors are unable to select and monitor transactions in the brokerage window. No monitoring, no fiduciary oversight. Plan participants are truly on their own. Yes, the participant has choice, but no one is riding shotgun on these account.
The Department of Labor recently asked for comments on the practical use of brokerage accounts within 401k plans, with an eye to providing fiduciary guidance on the subject. Specific issues are costs, monitoring, selection of providers and fiduciary responsibility. Here is a link to that request. Consider commenting.
If you are considering the use of brokerage accounts within your company’s retirement plan, please think about how these arguments will affect your people – both pro and con.