What is an ETF? — Part 18: 401(k) Plans

July 12th at 7:00am by Tom Lydon

Exchange traded funds continue to increase in number and popularity, growing to one of the most commonly traded securities on the stock exchange as both institutional and the average retail investor gain greater access to broad or specialized market exposure. Yet many individuals are unfamiliar with ETFs’ inner workings. In this ongoing series, we hope to address your questions and help shed light on the investment vehicle. [What is an ETF? — Part 16: Inverse and Leverage Funds]

ETFs help keep investment portfolio costs down. Consequently, investors are beginning to see the benefits of including ETFs in their retirement portfolios as the next logical step.

Mutual funds dominate the retirement 401(k) plans industry, but more investors are beginning to realize that the cost saving aspects ETFs have on non-retirement portfolios may also be used in 401(k)s.

ETFs do not come with redemption and management fees that many mutual funds require. As such the ETF industry has an average expense ratio of 0.55%.

Moreover, mutual funds held in 401(k)s tend to have higher fees than open end funds outside of 401(k)s – the securities traded are a a special R-Shares class of funds.

However, there have been some major hurdles that are barring widespread use of ETFs in the plans: No real cost-effective trading software has been implemented to allow participants to perform the necessary tracking. Accounts can’t own fractional shares of an ETF. ETFs trades are based on commission fees, like stocks, which may diminish returns due to the periodic salary-deferral contributions. [ETFs Face 401(k) hurdles]

Currently, ETFs account for less than 1% of the $1.2 trillion 401(k) market, with companies like ShareBuilder, Schwab, TD Ameritrade, Invest’n’Retire and ExpertPlan providing ETF options in their retirement plans.

If you would like to include ETFs in your 401(k), the best way is to let your employer known and begin asking ETF options that would work well with your retirement portfolio.

For past stories in this series, visit our “What is an ETF?” category.

Max Chen contributed to this article.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

Tickers