How 401K’s and Most IRA’s Limit Investment Options

Can your money stack up quickly with a qualified plan?
Can your money stack up quickly with a qualified plan?

The vast majority of Qualified Plans (which would include 401(k)’s, 403(b)’s, as well as self directed IRA’s (whether they’re Traditional IRA, Rollover IRA, SEP IRA, or any other) have very limited investment options.  Which means you’re not able to invest in the things that you might like to invest in.  If the best investment for you is not offered in your plan, what good does it do you to have money in this plan?  In such a case, isn’t this plan actually hurting you because it won’t allow you to invest where you need to?

This post is not meant to break down all the problems with the type of “investment” that are typically placed within these plans.  We’ll soon discuss the many problems with this type of investing that leads to people achieving a far smaller rate of return (if it’s at least positive) than what they might expect, or than what they’re IRA/401k provider showed them they should expect.

Let’s look at why these plans are set up this way, then we’ll break down the two major types to see specifically how they work.  Then we’ll look at the exceptions.

Most 401k/IRA’s are set up by a plan administrator attached to a financial institution.  As noted yesterday, these institutions have very strong vested interests in you investing your money with them.  There isn’t actually a law against most any type of investment being held within the plan, but many investments aren’t in the institution’s interest, and so are not offered to you within the plan set up by the institution.

If you want to invest in real estate, hold gold or silver, lend money, invest in a privately held company (maybe your own?), or do any other number of things – you can’t.  Because those activities don’t make the financial institution its profits, they don’t want you investing in them.  Ironically, the institution itself often invests in these sorts of thing with their own money all of the time, but for you, they are strictly forbidden.

When viewing plans in this way, there are really three types.  The first is administered by your work.  This could be a 401k, a 403b, or SEP IRA.  Your boss or HR department has signed an agreement with a financial institution and they have a plan that you can sign up for.  These will be the most limiting.  There are typically between 5 and 30 different mutual funds (or mutual fund like accounts) to choose from.  If you work for a public company, your plan might also offer you the opportunity to purchase your company stock within this plan.  There is no law against them offering you more, but it’s simply not in the institution’s interest and so they pretty much never do.

The second type is a plan set up with an institution by you directly.  Again, you are usually constrained by the institution’s offerings.  Some people who’ve been around a while believe that IRA’s are synonymous with bank CD’s because that’s the only way you used to encounter them.  Whether you’re setting up a new IRA, rolling over an old 401k or IRA to a new one, or beginning your own SEP IRA or other self employed vehicle, you’re probably doing it with a financial institution who is interested in your investing your money in certain ways.  Now, most of these institutions do typically offer you more options than what you would get through an employer.  It’s common to be able to invest in individuals stocks and a much wider universe of mutual funds.  Again, if these are not the best ways for you to invest your money, you are trapped with these options as long as you keep your money there!

The final option is to set your IRA up with an administrator who actually lets you invest it the way you want to.  There are smaller firms out there that charge you money based upon the number of investments that you keep within the account which do not make any money based upon what you invest in.  These are much more willing to let you invest in whatever legal way that you desire.  Their role is simply to make sure that everything is legal and report what you are doing to the government who is your partner in the account.

Tomorrow we’ll discuss lack of accessibility and control with these accounts.

This is _Part 13_ in the series titled The Trunk.  To continue with this series, click on Pt 14.  To use this as a growth tool, please read Pt 1, Pt 2, Pt 3, Pt 4, Pt 5, Pt 6, Pt 7, Pt 8, Pt 9, Pt 10, Pt 11 and Pt 12.

Photo credit: Darren Hester

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