Rule of Thumb for 401(k) Brokerage Fees?

[ea1776]

Hi all,

I am 25 and have ~10k in my 401(k). My company recently got bought out, and the new company's 401(k) offers a brokerage. I love investing in individual stock, but I'm wondering if the brokerage fees will make it worthwhile.

If you choose to invest within the self-directed, online brokerage, you have to pay quarterly fees of $25 plus $20/trade.

If you choose not to invest in the brokerage, you choose between a typical set of ~25 mutual funds (and you don't pay the above brokerage fees).

So my question is, is there kind of a minimum amount of capital I should have before it is worthwhile to use the self-directed brokerage?

I suppose it is more of a question of "how much more gains can I achieve in the brokerage over the 401(k) pre-decided mutual funds?".

It's also a matter of enjoying having FULL control over my investments. A certain piece of mind comes with that. But that incentive is emotional and not "bottom-line" oriented, so it's less important.

Anyways, thanks for any comments/insight.

[jIM_Ohio]

I think the issue is whether the return you get from the brokerage would be better than the return you would get from the mutual funds.

My company has a self directed brokerage option too. I am considering using it to take on more risk with my 401k monies than I do in my Roths and Rollovers.

I am weary of the $20/quarter fee I am assessed ($80/year), but if I get higher returns, the fees are not the issue I consider important.

If you do not get higher returns, stick to the funds offered.

[noppenbd]

I think it depends on the quality of the funds in your 401k, plus the fees associated with them. Paying the $100 per year in brokerage fees is the equivalent of an extra 1% expenses at your current 401k amounts, which is ridiculous. In addition, since the trading commissions are quite high at the brokerage window the break even would depend greatly on how often you will be making trades.

Without seeing your 401k fund choices it isn't possible to evaluate the choice on the numbers, but my gut tells me you would be better off avoiding the brokerage window at this point.

Once you reach a larger level in your 401k, I would also not suggest you buy individual stocks, but rather low cost mutual funds. With $20 commissions you are going to have a tough time getting good diversification cheaply. You would be better off going with a taxable account if you truly want to play the market.

[Broken Arrow]

To add, individual stocks are generally riskier because you are investing without the inherent diversification found in mutual funds and ETFs.... Which is fine if you are willing to commit to the time and effort of researching companies, to off-set the lack of diversification. It can be a lot of work.... That's something you'll want to figure out before you commit to this.

When it doubt, I would probably shy away from stocks... or at least try a simulator first.

The fees are pretty high too....

[ea1776]

Without seeing your 401k fund choices it isn't possible to evaluate the choice on the numbers, but my gut tells me you would be better off avoiding the brokerage window at this point.

Here's the funds I can choose in my 401(k).



If I used the stock window, I would own no more than 5 stocks at a time (4 large quality stocks with high paying dividends, 1 speculative stock, all in different sectors of the market), with a 25% cash position (to take advantage of buying opportunities in the market). I would probably make 5-10 trades on average per year, so my total cost would range from $180-$280/year to use the brokerage.

I'm thinking I should hold off until I build up 20K in the account, then take advantage of the brokerage window at that time. That'll give me more time to test out strategy simulations before using my real money.

Any advice on how my portfolio should look (allocation-wise) using the given funds? I am 25 years of age. I contribute 5% of my income, and employer matches 100% of that 5%. (That comes out to about 7K contribution/year currently.)

[jIM_Ohio]

Here is something to consider-

Invest half in funds (come up with growth oriented allocation) and invest half in brokerage.

My SDB requires the following:
$500 minimum in brokerage account at all times
new desposits are made to 401k funds (which can be sold and then moved to brokerage). Rebalance each year between the funds and brokerage (maybe 2X per year if needed). Move money to brokerage in $10,000 increments (so it is easy to track rates of return).

I plan on doing something similar.
I have 40k in my 401k. I plan to leave 10k in the funds and move 30k into brokerage. I don't get this option until June (most of my old 401k does not move to new 401k until June based on plan transfer rules).
Within the brokerage, I plan to use a similar allocation to what I have now, with aggressive funds making up 1/3 of each position.

42% large cap domestic (28% diversified in PRFDX and 14% aggressive in something else).
15% mid cap domestic (10% diversified in PRDMX and 5% in CGMFX)
15% small cap domestic (10% diversified in PRDSX and 5% in a Bridgeway fund)
15% in TRIGX (unless I find an aggressive international fund, in which case I will go 10%-5%)
10% in PRIDX (unless I find a better way to divide the 25% international allocation).
3% bonds in RPSIX

I contribute 7k to my 401k each year, my match increases that to around $9500. This is DCA'd into the mutual funds company offers in similar allocation (42-15-15-15-10-3).

I then track rates of return and see if the aggressive positions trump the $80 costs each year. $80/$30000=I am dealing with .3% higher return to cover the expenses.

In addition the funds on the brokerage side have higher expenses than the ones my company offers, so I know I need to pick well in order to make brokerage plan work.

[noppenbd]

For your current 401k I would suggest

25% Polen Capital Large Cap Growth
25% NFJ Dividend Large Cap Value
15% Wells Capital Small/Mid Cap
15% Calamos Small/Mid Cap
20% Julius Baer International Growth

I might tweak this or eliminate some funds based on past performance and/or expenses. See if you can get this info for the funds.

EDIT: I also would definitely point out that 5 stocks in your 401k brokerage is in no way diversified. There is risk, and there is measured risk. Having your whole (or even half of) your 401k riding on 5 companies is a bad idea IMO. Think Enron, Bear Stearns, Worldcom, etc. Stick with index ETFs or mutual funds.

[ea1776]

For your current 401k I would suggest

25% Polen Capital Large Cap Growth
25% NFJ Dividend Large Cap Value
15% Wells Capital Small/Mid Cap
15% Calamos Small/Mid Cap
20% Julius Baer International Growth

I might tweak this or eliminate some funds based on past performance and/or expenses. See if you can get this info for the funds.

EDIT: I also would definitely point out that 5 stocks in your 401k brokerage is in no way diversified. There is risk, and there is measured risk. Having your whole (or even half of) your 401k riding on 5 companies is a bad idea IMO. Think Enron, Bear Stearns, Worldcom, etc. Stick with index ETFs or mutual funds.

Thanks for the post. I would argue that you *can* stay diversified with only 5 stocks and a 25% cash position. This means any one stock has <= 15% of your 401(k) capital at any given time.

I define diversification as spreading out your capital among solid investments across several *sectors*. For example, I would rather own 2 of the most quality stocks in the S&P 500 in 2 totally different sectors (tech/pharmaceutical), than an equal share of the entire S&P500 (index fund).

Your point is well taken though. With this style of investing, you would definitely want to choose investments very carefully, and do a good amount of research while you own them as well. I also believe I can afford greater risk due to my age.

[noppenbd]

Thanks for the post. I would argue that you *can* stay diversified with only 5 stocks and a 25% cash position. This means any one stock has <= 15% of your 401(k) capital at any given time.

I define diversification as spreading out your capital among solid investments across several *sectors*. For example, I would rather own 2 of the most quality stocks in the S&P 500 in 2 totally different sectors (tech/pharmaceutical), than an equal share of the entire S&P500 (index fund).

Your point is well taken though. With this style of investing, you would definitely want to choose investments very carefully, and do a good amount of research while you own them as well. I also believe I can afford greater risk due to my age.

How would this strategy have protected you from selecting an Enron, Countrywide, or Bear Stearns? If you had done this you would have lost 15% of your porfolio in one hit. I don't think any amount of research or time will protect you from this risk.

If you want to diversify by sectors you could choose sector ETFs. Even that would be less risky than going with single stocks in your 401k.

[jIM_Ohio]

Thanks for the post. I would argue that you *can* stay diversified with only 5 stocks and a 25% cash position. This means any one stock has <= 15% of your 401(k) capital at any given time.

I define diversification as spreading out your capital among solid investments across several *sectors*. For example, I would rather own 2 of the most quality stocks in the S&P 500 in 2 totally different sectors (tech/pharmaceutical), than an equal share of the entire S&P500 (index fund).

Your point is well taken though. With this style of investing, you would definitely want to choose investments very carefully, and do a good amount of research while you own them as well. I also believe I can afford greater risk due to my age.

What you are talking about is a known technique managed funds use all the time- overweighting strong sectors. What you need to realize is this:

a) if one stock in sector has bad news, it tends to take the whole sector with it. Enron took down energy, worldcom took down tech and telecommunications.
b) the DOW is diversified with 30 stocks. Some others have researched that having around 15 stocks is more than enough, and owning more than 16 stocks does little to improve return or reduce volatility. Yet when you look at S&P 500 index, it is considered quite volatile.
c) a common investing technique is making large bets on minimal positions. Janus 20 and many other mutual funds do the same thing (is Janus 20 even around anymore?).

IMO the goal of investing is the best risk adjusted returns. If two investments have an 8% return, the one with the least risks is the best investment. If two investments have a 4% return, the one with the least amount of risks is the better investment.

If you are looking at stock investing, my advice is learn more about small caps and IPOs. That is where the real high returns are. Placing bets on Microsoft, Dell, Oracle, GE or P&G will get you market returns, maybe plus or minus a percentage. Hardly worth the risks. You might get the 8% return of the market, maybe 9-10% return. But you could get that same return with less risk in a mutual fund investing in the whole large cap index or a managed large cap fund.

Small caps on the other hand have huge possible returns. I read that the bull market of the 90's was due to 5-10 companies growing at 100X market cap. Out of nowhere Cisco, Intel, Microsoft, Dell, Oracle and a few other small companies rose up and created the bull- which then lifted the profits of the companies around them (tell me a company which does not use a product from 4 of those 5 companies).

As I invest in stocks, I usually look for small or mid caps to buy small positions in now, then hold them for years and years in a taxable account. Because as the company grows, my small position will become quite large.

With mutual funds I look to double- get a 2 bagger- every 5-7 years.
With stocks, Peter Lynch always commented to look for the 10 bagger- look for the stock you can hold and hold and get a 10X return on or 100X return on.

[noppenbd]

Jim is giving you so great advice, and I don't disagree.

As he said, I would not try to do this in your 401k, especially if you are new to investing. Try your hand at picking stocks for a few years in a small taxable brokerage account, and see how you do. That way if you do get some losses, at least you are can write them off, and you are not putting a large amount of capital at risk.