Playing penny-ante with your 401(k)
Should I take advantage of the self-directed brokerage account offered by my 401(k)?
NEW YORK (CNNMoney.com) - I'm 26 years old and contribute 6 percent of pay to my 401(k), which my company matches. Aside from a menu of 18 different mutual fund options, my plan also has a self-directed brokerage account option that allows me to invest in stocks and other investments. I have the desire to invest and I follow the market news intently, but the minimum fees to trade seem high. Would I be wasting my time investing my 401(k) money through this brokerage account, or is this something that's worth a try?
-- Jason Tallafuss, Orlando, Florida
If wasting your time were the only risk here, I'd say, sure, make like Mad Money's Jim Cramer and knock yourself out betting on winners and losers among individual stocks. But you've got more to lose here than time -- you could be squandering your retirement savings and jeopardizing your financial future.
So I'm going to be very blunt with you. I think self-directed brokerage accounts are one of the worst "innovations" to hit the 401(k) arena. And I think you would be making a big mistake to make this sort of account the cornerstone of your retirement investing strategy. (Indeed, I don't even think the word "strategy" would be appropriate.)
Most people can't outperform the market. Period.
It's tempting to think that by following the market and doing some research that we can outperform the market averages and bulk up our nest eggs. But studies show that the more people trade, the less they typically earn, both because the cost of trading drags down returns and because most people aren't very good at timing their moves in and out of individual securities.
To see how individual investors fare buying and selling stocks, just take a look at the research of University of California, Berkeley professor Terrance Odean.
If you insist on giving the stock-picking game a whirl, I suggest you set aside a small pot of non-retirement money at a low-cost discount brokerage firm -- you can call it your own little "mad money" account -- and see how you do over the course of a year or two. This way you can get a taste of how difficult it is to make a profit by trading stocks without putting serious money at risk.
Build a diversified portfolio instead
If you want to be serious about investing your 401(k) stash for long-term growth, however, you'll forget about this quixotic trading notion and instead begin thinking of ways to build a diversified portfolio of funds out of some of those 18 options in your plans.
You won't need all 18 -- in fact, you can probably get by with half a dozen or less. What's important is that you create a portfolio that has exposure to a broad range of stock funds -- large-cap, small-cap, growth and value -- and a small dollop of bond funds to give your portfolio a bit of ballast.
For details on how to build that portfolio of funds, I recommend you check out our Money 101 Asset Allocation lesson and then go to our Asset Allocator for specific guidelines on how to divvy up your 401(k) assets based on your investing time horizon and tolerance for risk.
As for choosing from among the 18 funds on your 401(k) menu, I suggest you check out our Money 101 Lesson on Mutual Funds and also take a look at our MONEY 65 list of recommended funds. Even if none of the MONEY 65 funds are available in your plan, you can still apply the methodology we used in compiling the MONEY 65 lineup to the funds available to you.
Add more to your 401(k)
One final suggestion: while you certainly want your 401(k) money to earn a competitive return, the surest way to end up with a nice big nest egg at retirement is to increase the size of your 401(k) contributions.
One of my recent Long View columns in MONEY Magazine cited compelling research showing how even Average Joes can get rich by boosting their contributions to their retirement plans. Even more important, the evidence suggests that higher contributions has a much bigger impact than better investing. I suggest you read the column, which you can do by clicking here.
So build a well-balanced portfolio with funds, start contributing more than 6 percent of salary and forget about that self-directed brokerage option.
Picking individual stocks may be okay for entertainment value. But it's not a very wise strategy for most people to achieve a secure retirement.
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