By Dr. Jim Dahle, WCI FounderI faced an interesting dilemma recently. Not only do I have a lot of influence over The White Coat Investor company 401(k), but I also serve on the committee for my partnership 401(k)/profit-sharing plan that covers several hundred docs in multiple states. It's pretty much always been a great 401(k) the whole time I've been working, but a little tweak now and then isn't a bad thing.
Trust me, I've seen PLENTY of bad 401(k)s that WCIers have sent me over the years. Companies and partnerships need to remember they have a fiduciary duty to their employees, and offering a slate of high-fee, poorly performing, actively managed mutual funds in your 401(k) is a great way to open yourself up to a lawsuit from a disgruntled current or former employee.
It was interesting to see how the assets in my partnership's 401(k) were divided. About 1/3 was invested in the low-cost index or index-like mutual funds, mostly from Vanguard and DFA, that the committee had selected. Another 1/3 of the dollars was invested in the “default” low-cost Schwab index target retirement funds. The last 1/3, like my 401(k) dollars, were all in the Schwab Personal Choice Retirement Account (PCRA), basically the brokerage window. Individual investors and/or their advisors take advantage of the PCRA option (Fidelity has something similar) when they want to invest in something the 401(k) doesn't offer. In my case, that's SCHP (a Schwab TIPS ETF) in my tax-deferred account and VNQ (the Vanguard REIT ETF) and AVUV (the Avantis small value ETF) in the Roth 401(k) account.
Frankly, we've got a decent TIPS fund in the 401(k) and VNQ already, so I guess the only reason I'm bothering with the PCRA right now is AVUV. But it's so easy and low cost to use, I don't see any reason not to just PCRA everything so long as you're comfortable directing your own investments.
The interesting thing about the PCRA option was that, as a committee, we could put restrictions on the investments that our colleagues were allowed to use. And there were a lot of options. All of the following investments and more could be specifically allowed in the plan or specifically excluded by the committee:- Individual stocks
- Individual bonds, including municipal bonds and Treasury bonds
- Inverse ETFs
- Leveraged ETFs
- Private partnerships/K-1 delivering investments (think real estate syndications)
- Options
The discussion came up because one member of the partnership wondered why he couldn't buy a Treasury bond. Apparently, we had disallowed that, even though he could invest his entire 401(k) balance into NVIDIA stock. What followed was a philosophical discussion about how much freedom we could offer to the 401(k) participants while still maintaining our fiduciary duty to them.
Now, when one goes to the PCRA option, they're already sort of acknowledging that this is all on them (and their advisor, if they have one). But does that mean we should let them invest in ANYTHING they can buy at the Schwab brokerage? What responsibility do we have to keep someone from blowing up their whole retirement plan by market-timing a non-diversified assortment of 3X leveraged inverse ETFs?
In the end, we lifted the restriction on Treasuries but left restrictions in place on inverse ETFs, leveraged ETFs, options, and K-1 investments. It might be limiting freedom a bit, but if you want to invest in that stuff, I figure you can do a self-directed Backdoor Roth IRA or just save enough to invest some in taxable. If you actually need to hit a home run perfectly timing those sorts of investments with your 401(k) dollars to reach your financial goals, I'm sorry, but you're still probably better off not investing in them.
In the WCI 401(k), we opted to give participants a little more freedom and a little less paternalism. But we're also a company where nobody can work here for very long without knowing the proper way to invest. Besides, so far, I think Katie and I are the only ones doing anything interesting (a couple of real estate debt funds) in the 401(k), anyway.
What do you think? If you were in charge of a 401(k), what types of investments would you allow or disallow in it and why?
I manage my wife’s 401k and it’s roughly 10% of our overall portfolio. She has part of her investments in PCRA. I don’t want any restrictions and would not be happy if there were. This whole point of moving to the PCRA is to access other investments with maximum flexibility and choice. If we want to take risky bets with the PCRA because that’s the most convenient money available, that should be our call not the employer’s.
Most employers are perfectly content for you to take on that risk, so long as you don’t come back and sue them afterward for letting you.
I think it is quite reasonable to use leveraged ETFs to create a well diversified portfolio with roughly 100% equity exposure and a good deal of ballast. That should give long term returns similar to 100% equities but less volatility.
There is a spectrum between a well researched and moderate use of LETFs and a Wall Street Bets approach. At one endpoint fiduciary would allow usage, the other end no.
I don’t envy having to make the call.
I don’t get the sense most people are using leveraged ETFs that way, but there is an argument to take less market risk and more leverage risk to reach goals, whether that leverage is internal or external to the investment.
I agree.
It seems like the perception is that either (i) any use of LETFs is grossly irresponsible and bad things are just waiting to pounce or (ii) yolo baby! You don’t hear about the boring middle ground much, although we do exist.
The yolo group is where fiduciary responsibilities come in.
Maybe it takes a significant portfolio to protect, some burnt fingers, and fears of sequence of returns risk that gets one into the middle ground. I surely don’t see an easy way to accommodate the middle ground folks while restricting the yolo folks that doesn’t get into tracking portfolio composition.
I dunno, man. If you’re a little too conservative, then folks get butt-hurt. But if you let them do whatever they want with their money (which you are acting steward of, right?), and they screw it up (which they WILL… the data shows this), then your 401k administers can get sued.
Seems like a pretty easy call to me.
Go gamble on Robinhood with your pocket change like the rest of us.
I cant seem to find this on the Forum.
I have argued that 96% of the people using our 401k are/were/will be accredited investors, so good luck suing us for their brokerage misadventures (when the default is a wicked low cost life cycle fund). That said, ive never looked at what people are doing in there!
Interesting it didn’t automatically crosspost to the forum as usual. Not sure why. But if you don’t want to miss blog posts, best to just subscribe to the emails I guess. The crossposting seems to be working again today.
I’ve addressed brokerage window concerns here in detail:
https://www.whitecoatinvestor.com/medical-practice-group-retirement-plans/
ERISA 401k plans have very specific requirements regarding what types of investments are allowed in brokerage accounts tied to the plan. So while solo 401k plans can allow more options, ERISA plans have a specific list of restrictions for investments that can not be bought, such as farmland, real estate, physical gold, bitcoin, etc. Some brokerage accounts may have been opened via retail brokerage outside of the plan, and those brokerage accounts are what puts the whole plan at risk as they are never restricted, so when we find issues with brokerage windows, these are almost 100% due to unrestricted outside accounts.
There are reasonable restrictions that can and should be placed on ERISA brokerage accounts even if all participants are sophisticated investors. If staff is involved, even more care has to be taken as brokerage window is offered to all staff, not just the partners.
In a group plan with outside advisers who may or may not be doing the right thing for their clients, even more care has to be taken to ensure that clients are not harmed by their advisers via various potentially high risk strategies including options trading. Even if the partners are sophisticated investors, when bad things happen, they can still sue the plan sponsor for damages if something bad happens in their account, and to avoid the risk of that, it makes a lot of sense to restrict the types of investments offered in such accounts, even if only to protect the plan sponsor from excessive liability.