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Should ETFs Be In Your 401k?

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Lately, ETFs or Exchange Traded Funds have gained more attention in 401k plans. It’s quite easy to understand why because ETFs hold many advantages over other investment types. However, as of today, ETFs only make up under 1% of the total assets in the United States defined contribution plans.
If ETFs are so good, then why hasn’t it been making a bigger impact on 401k plans?

What’s There to Love about ETFs?

You will see that there are several reasons why ETFs are currently the talk of the town. First of all, ETFs have low expenses, and it doesn’t have the usual 12b-1 fees regularly found in 401k plans because of the transparency it practices. Aside from that, research shows that these low-expense funds have consistently bested high expense funds for each period and asset class examined.

[Mutual Funds vs ETFs]

This is highly advantageous since it can lower expenses by almost 50% in the regular 401k plan. In a normal plan, an employee can have fees ranging from 1.5-2.5%, sometimes even higher, whereas expense ratios for ETFs can amount to just 0.50% or even as low as .10- .20% in major funds.

These figures alone give us an idea of how affordable ETFs are, making them a wise investment to add to any portfolio. As the saying always goes, we cannot control the market, but we can always control the cost.

What’s the Problem?

With the statistics reported in many major finance publications such as Forbes and The Wall Street Journal, why aren’t ETFs being welcomed in all 401k plans? Like any new idea, there will always be skeptics. It is said that although ETFs can offer a clear cost advantage in terms of expenses, the problem lies in trading them. Investors must often need to pay the broker’s commissions to buy and sell the fund, unlike the other funds in the usual retirement plan. Also, if it’s low cost that you’re looking at, index mutual funds are already low cost, as emphasized by Ary Rosenbaum, an attorney specializing in retirement plans in New York.

Another barrier to ETFs is that most major corporate retirement plans have mutual funds at the lowest cost, which can negate the ETFs pricing advantage. Aside from these mutual funds, collective trusts which are institutional accounts handled by banks are also accessible by corporate plans at very low costs.

Smaller companies also face the roadblock of operating costs. The usual investments in 401ks, such as traditional mutual funds, usually bundle their fees effectively passing on the burden to the employees. These fees also work by compensating financial advisors and other service providers. Most of the time it also pays for administration and record keeping.

With the transparency of ETFs, companies won’t be able to benefit from fees, which can help cover their operation costs.

Do These Criticisms Hold Weight?

One of the most popular criticisms against ETFs in corporate plans is a white paper entitled “Why ETFs And 401(k)s Will Never Match” written by David Blanchett, an internal consultant for Unified Trust Co. and Gregory Kansten, Unified Trust Co. President. Some of the objections raised were:

  • The technology to incorporate ETFs in 401k plans has not been developed yet, making record keeping difficult.
  • ETFs have two primary transaction costs–the bid and ask spread and the broker’s commission.

First of all, what Blanchett and Kansten failed to research is that a record keeping firm, Invest n Retire, has already been successfully adding ETFs into their retirement plans, as well as keeping a stellar record. As for transaction costs, the authors failed to consider that the stocks and bonds in mutual funds are also being traded in the open markets. Their fees however, are neatly packaged into the fund. This oversights cause their theories to be flawed.

Big Companies Making the Shift

Despite the criticism ETFs in 401k plans may draw, there are big companies who are supporting this kind of plan. Among these trendsetters are iShares who have invested $2.7 billion in ETF based 401k plans last 2010. Other companies include SPDR, Vanguard, ING Direct, and Folio Investments.

Despite the initial attacks on Exchange Traded Funds being incorporated in corporate 401k plans, big leaders who are setting the trend can eventually convince other companies to shift to ETFs as well. This could ultimately mean more transparency in 401k plans, making retirement more affordable to regular employees.

What do you think about ETFs?

Dominique Brown is a financial planner, landord, personal finance blogger and video blogger. He is the owner of YourFinancesSimplified.com where he talks about everything from being a new father to his worst financial mistakes. He has been featured on The Huffington Post and H&R Block. You can find him either on Twitter, Facebook, Youtube or Instagram.

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AUTHOR Derek

My name is Derek, and I have my Bachelors Degree in Finance from Grand Valley State University. After graduation, I was not able to find a job that fully utilized my degree, but I still had a passion for Finance! So, I decided to focus my passion in the stock market. I studied Cash Flows, Balance Sheets, and Income Statements, put some money into the market and saw a good return on my investment. As satisfying as this was, I still felt that something was missing. I have a passion for Finance, but I also have a passion for people. If you have a willingness to learn, I will continue to teach.

7 Comments

  1. I love ETF’s. I have a couple in my IRA. 1 is doing nicely. The other tanked about a week ago. However the interest is making up for it. I won’t be retiring anytime soon so I don’t mind holding out.

    • Why did it tank?

  2. I love ETFs, although I think some of the new “active” ETFs that blur the line between an ETF and a mutual fund are just trendy excuses to charge a fee.

    I’d love to see ETFs in 401ks become widespread options. I agree, though, it’s going to take a lot of work to get them there.

    • There definitely are a lot of trendy ETF’s, but the ones that mimic the holdings of mutual funds are often times much much cheaper as far as expense ratio’s are concerned.

  3. I have a couple of broad index ETFs. They keep me diversified.

  4. In your 401k?

  5. Yes, i invest in EFT too to diversify my investments.


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