Why 401(k)s and ETFs Can Work Together | ETF Trends

Everyone loves exchange traded funds (ETFs). Well, unless you count 401(k) plans, most of which have curiously been leaving the much-adored securities off their list of available plan options. What gives?

ETFs are adored for a number of reasons: they generally have lower fees than most mutual funds, offer tax advantages and can trade like stocks, and, thanks to a price war, commissions on trading them are lower than ever, says Ari Weinberg for The Wall Street Journal. [Why Retirement Portfolios Need to be Rebalanced.]

But most 401(k) plans haven’t yet incorporated them. Some of the reasons cited have been:

  • ETFs just aren’t a good match for 401(k)s. The big advantages that the funds offer get lost inside 401(k)s, these advisers say, and ETFs can bring technical headaches for the companies that manage the plans, so many don’t want to offer them. Plans like Invest n’ Retire and ING Direct’s ShareBuilder 401(k) have proved that these “hurdles” can be easily overcome.
  • In a 401(k), investors typically won’t be able to take advantage of one of the key appeals of ETFs—the fact that they trade all day long rather than just once a day, as is the case for mutual fund shares. Stuart Robertson for ShareBuilder 401(k) says that this is a non-issue: most plan participants don’t log in more than a few times each year and don’t consider intraday trading.
  • Large corporate plans have access to the lowest-cost mutual funds, stripping the price edge from ETFs. But there are several problems with this:a) 12b-1 and other fees are often tacked on.
    b) Many of those mutual funds still have a focus on beating the market rather than tracking it.
    c) Just because the corporation qualifies for the lowest-cost share classes doesn’t mean that’s what’s in the plan. Corporations have to remember to review the funds and work with the provider if there are better share classes to be had.

    Lastly, Robertson points out that professional managers have a difficult time at best trying to beat the indexes over the long-term. Corporations may still have access to the lowest-cost share classes, but they’re still mutual funds.

This brings us to an issue in the 401(k) world known as “yapping dogs.” Carolyn T. Greer for The Wall Street Journal reports that these dogs are actually retirement accounts people leave behind at old places of employment. They can be dangerous and costly if you’re not careful.