The Making of an All-ETF 401(k) Plan | ETF Trends

In less than 20 years, the exchange traded fund (ETF) industry has grown from a fledgling outlier with just a few funds to a rapidly growing behemoth with nearly $800 billion in assets in the United States alone. Now that they cover the majority of sectors and asset classes, the attention has turned to a new frontier: the 401(k) plan.

It’s been said that if ETFs were able to crack this market the way mutual funds have, the industry’s growth would be all but unstoppable. While that hasn’t yet happened, there are still a few 401(k) providers on the front lines who do offer all-ETF plans. [401(k)s: The Last Hurdle.]

We caught up with Stuart Robertson, General Manager and Principal at ShareBuilder 401(k), to talk about how ETF 401(k) plans are constructed, why they include what they do and what a safe, responsible plan would look like.

Why 401(k) Plans Look the Way They Do

Robertson says that from a regulatory standpoint, there are two things 401(k) providers need to do:

  • They need to act in the best interest of the employees.
  • They need to offer diverse investments that help minimize the risk of huge losses. Every plan needs to have at least three fund types, such as a mix of bonds, equities and cash.

401(k) plans – ETF or otherwise – won’t contain every investment option available simply because it wouldn’t serve the first purpose well. “When you have 800 ETFs,” says Robertson, “you can almost lop off the risky or narrowly defined ones.” [The All-ETF 401(k) – It’s Happening Now.]

From there, providers will often select a few ETFs to cover the major asset classes, a few specialty funds for the more sophisticated users, and perhaps some Treasury funds.

The second rule, that there needs to be a mix of fund types in a 401(k) plan, was one that was written years ago. “There are thousands of options – major asset classes, equities, money markets, specialty markets,” he says. In assembling a plan, providers should be thinking about what benefits its participants most.

The reason the pickings are kept on the slim side are for multiple reasons, the main ones being that it minimizes the chance for a large loss and it helps plan participants succeed. Another point, Robertson says, is that giving people too many choices ultimately overwhelms them and 401(k) participation rates decline. [401(k)s Shift to the Younger Set.]

“You have to keep it simple,” he says.

The Market Meltdown

In 2008, the market took a nasty turn that ultimately led to the so-called Great Recession that caused many investors to lose 40%, 50% and even 60% of their retirement plan’s value. If 401(k) plans should be designed to protect their investors, what went wrong?

Aside from the fact that the S&P was down 38% that year, another issue might have been inappropriate allocations.

In most plans, Robertson says, the company gives participants a series of options that fit the general regulatory requirements. After that, they’re left to fend for themselves and many may have made choices that were inappropriate for their age.