Pros and Cons of a Self Directed 401k

by Investing School on May 18, 2011

In contrast to the more traditional 401(K), where the employer determines who holds the accounts and which products can be purchased, the self directed 401(K) offers the owner more options. The freedom to choose one’s investments and “play the market” encourages more direct involvement in retirement planning.

This is a retirement account where the investor assigns an account custodian and then proceeds to make their own decisions regarding which stocks, bonds and/or mutual funds to purchase. Typically set up at a brokerage firm, the investor is usually charged a specific amount above trading costs for operating their IRA. These increased costs can decrease returns.

That said, it should be mentioned that even when an employer allows workers to participate in a self directed 401(K) there are limits imposed. For example, only a specific percentage of the accrued retirement funds may be released for self direction. In other cases only certain commodities may be traded.

The disadvantages of having such a wide open field of potential investments can be overwhelming for individuals unfamiliar with the market. Additionally, the costs of maintaining such an account are invariably higher. Frequent purchases and sales and poor selections can lead to greater losses which employers fear may lead to lawsuits as well.

The choice of participating in a self directed 401(K) is a very personal one, but it is recommended that any employee choosing to do so do a lot of research in to the market before making purchases. While there is the potential for greater gains, the risks are proportionately larger too.

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