New 401(k) Fee Disclosure Rules Would Give Low-Cost ETFs an Edge
September 5th, 2012 at 6:00am by Tom Lydon
The mutual fund 401(k) retirement plan industry is under fire as new disclosure laws will give investors a glimpse of what they are actually paying for, providing a chance for the upstart exchange traded fund industry to jump in.
At the end of August, the new Department of Labor rules on fee transparency will take effect, requiring 401(k) funds to disclose underlying investment expense ratios and the amount per $1,000 it costs to be invested in those funds, reports Tom Gonnella for RIABiz. [What is an ETF? — Part 18: 401(k) Plans]
According to a Deloitte and the Investment Company Institute study, investment expenses in 401(k)s make up 84% of a plan’s cost.
The new fee disclosure laws may be a boon for the low-cost, highly transparent, passively managed ETF industry. Due to their passive nature, most ETFs do not require a hefty management fee – the average ETF comes with a 0.55% expense ratio.
For example, in a hypothetical $25,000 investment with a 1% fee disparity, the difference between a 6.5% return and a 7.5% return on the investment over 20 years amounts to $18,105.15. Over extended periods, the small 1% will accumulate.
Additionally, ETFs come in a more tax efficient structure, but this key selling point does not apply as much to the 401(k) market as much as it does with retail equities investors.
Gonnella, though, cautions that the new information may not be enough and could even serve to confuse plan participants and employers. For instance, participants will have to add the hard-dollar expense from their quarterly statement with the investment expense they will need to calculate themselves – 401(k) providers are not required to explicitly state “you paid X dollars to the Y fund manager.”
“So unless a sponsor has a mechanism to calculate the average daily balance of the underlying investments throughout a calendar year, any well-meaning, manual fee calculation is usually inaccurate, not to mention time-consuming,” Gonnella said.
Meanwhile, ETFs still face hurdles in getting into the 401(k) space as many of retirement plans are geared toward mutual fund providers. For example, ETFs are traded on an exchange during normal market hours and incur commission fees on trades. The funds are also only traded in full shares, so some money may not be fully invested. [ETFs Face 401(k) Hurdles]
Critics have also been quick to point out that the quick tradability found in the ETF investment vehicle may encourage active day trading in retirement accounts. The naysayers believe that since the 401(k) plans are long-term investments, investors should only be limited to diversified, asset-class ETFs instead of specialized sector funds.
For more information on ETFs in 401(k)s, visit our 401(k) 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.