The 401(k) market is seen as the final frontier for the exchange traded fund (ETF) industry to traverse. But there are already pioneers out there staking a claim on this new front. One of them is ING Direct’s ShareBuilder 401(k).
We caught up with ShareBuilder 401(k)’s General Manager and Principal Stuart Robertson, who discussed the benefits of having ETFs in 401(k) plans, why it’s been so slow to catch on and ShareBuilder 401(k)’s own role in the space.
When your company pioneered an all-ETF 401(k) plan in late 2005, ETFs weren’t recognized as a fit for retirement plans. What did you see back then that other providers didn’t?
A. We saw a marketplace typically serviced by more complex and higher-expense funds. This can be very confusing and costly to employers and employees, especially for small businesses. With exchange traded funds (ETFs), we saw the opportunity to build what we believe is a better 401(k) plan for America. ETFs offer lower expenses, a broad array of choices across asset categories and fee transparency. Both mutual funds and ETFs offer solid diversification options for 401(k) plans, but ETFs are often a much lower-expense solution and this can make a big difference in building savings for retirement. [Special Report: 401(k) Plans, ETFs and You.]
What are the differences between a traditional 401(k) made up of mutual funds and one that’s composed only of ETFs?
The majority of 401(k) plans are very different from ETF-based 401(k) plans. ETF-based 401(k) plans are almost universally taking an index-based approach to investing whereas traditional 401(k)s take a more actively-managed approach.
Another related reason is cost.
Traditional 401(k) plans tend to offer actively managed mutual funds with just a few lower-expense index mutual funds. Actively managed funds typically incur greater costs in research and trading than an index fund. For each extra dollar spent, the fund must overcome these expenses to outperform its benchmark index (typically the success measure of the fund). [Slowly But Surely, ETFs Ease Into 401(k) Plans.]
These higher expenses would be fine if evidence supported that actively-managed funds were consistently outperforming the indexes. But overall, they’re not. While no one can predict the future, history has sided with index funds. Across major asset categories, the benchmark indexes have historically beaten 60% to 75% of actively managed mutual funds over a five-year period of time, according to the Standard & Poor’s Indices versus Active Funds Scorecard.
There are other technical differences on how shares are offered, bought and sold, but it still comes down to core cost differences. Over time, high-cost funds can be a big drag on how much a person can save for retirement. That’s why ETFs are a great fit for retirement plans.
Are ETFs in 401(k) plans offered different than those traded at retail?
The ETFs you can find at any online or brick-and-mortar broker are exactly the same as the ones you’ll find in ETF-based 401(k) plans. However, ETFs in 401(k) plans are often offered differently in two ways:
- No transaction fees. Transaction fees are common in retail, but are not typical in 401(k) plans. ETFs offer investors the opportunity to be traded throughout the day like a stock and most brokers charge to cover the cost of these trading transactions. However, most ETF-based 401(k) plans tend to limit you to one trade per day, per ETF much like mutual funds are in general. 401(k) plans service long-term investing strategies versus what is required to service retail investors and day traders. [What’s Holding ETFs Back from the 401(k) Market?]
- A preset line-up of fund options. In the retail space, you can choose between hundreds upon hundreds of ETFs. Not so with most 401(k) plans. Employers take on a responsibility to offer funds that are aligned with an investment policy, and research shows the more options available leads to fewer people that participate in the 401(k) plan. Both drive the need for a focused line-up of funds in 401(k) plans.
There is a lot of discussion around fee transparency in 401(k) plans. How do ETFs help?
For one thing, ETFs help participants to more clearly understand what they’re paying for. With mutual funds in retirement plans, you often run into “alphabet soup.” That is, there are often many different fund classes such as A, B, C, R, and I shares for the same fund. There is little to no difference in the stocks and bonds that make up the specific fund and its share classes.
What is different is the cost. One class of the fund may carry a load (front or back) or simply carry a higher expense ratio than another share class. These costs pay primarily for distribution (the person who sold you the plan) and marketing. The lower-expense, no load fund will be a better value for an employer and his or her employees. [401(k)s: The Last ETF Industry Hurdle.]
Unlike mutual funds, ETFs have no variety of share classes so there’s no confusion in what you’re paying for.
I see that when you launched ShareBuilder 401k, you entered the market with plans designed to service small businesses. Are ETF-based 401(k)s especially suited for smaller companies? If so, why?
ETFs are a great solution for 401(k) plans. Two things stand out in particular that make ETFs well-suited to serve small businesses from both a customer and business perspective:
- Low-expenses. While large companies with big 401(k) plans may qualify for the best mutual fund share classes that are more competitive with ETF expense ratios, most small businesses don’t and won’t – ever. ETFs enable a small business to have a plan with fund expenses right in line with the big firms. [ETFs vs. Mutual Funds.]
- No investment bias. While 401(k) plans are very common in large companies, that’s not the case for small business. From our research, we’ve found that roughly 20% of businesses with fewer than 50 employees have a retirement plan. That’s about one-third of the U.S. work force without access to a retirement plan. In selling to a large company, the decision-makers are often comfortable with their fund lineup. But, if you’ve never had a 401(k) plan before or feel your plan has higher expenses than you’d like, it’s easier to have discussion on the best fit for your retirement plan. [401(k) Plans That Use ETFs.]
Why aren’t more providers offering ETFs as an option in their 401(k) plans today?
ETFs are a big change for an industry that’s been built around mutual funds for the simple reason that ETFs didn’t exist when 401(k)s came into being. Some providers are concerned about, and have yet to understand, how to manage record keeping for ETFs. Others are concerned about how ETFs may affect revenue. Yet providers are seeing the inroads ETFs have made and will need to work this out. [IRA Assets Growing.]
How can companies and employees get ETFs into their 401(k) plan?
You can start by asking for them to be added to your current plan or by seeking out providers that offer them. I’ve often referred to this as the “I want my MTV” phenomenon. In the 1980s, customers had to ask their cable carriers to offer MTV and, after a few years, MTV became a cornerstone of cable TV. The good thing is that a business isn’t held hostage to a few providers unlike the cable industry. Even with that difference, we expect it will take another five or so years, until ETFs are a common offering from most providers. We need to keep educating employers and employees about their benefits, and businesses need to keep asking their providers for ETF-based plans. As this continues to happen more providers will support it. [ETFs and the Retirement Problem.]
Stuart Robertson is general manager and principal of ShareBuilder Advisors, LLC which operates www.ShareBuilder401k.com. ShareBuilder Advisors, LLC is a subsidiary of ING Bank, fsb.