Long-term investors have been looking into exchange traded funds (ETFs) as a possible instrument to plan for the golden years ahead, but the financial tool has not made significant headway into 401(k) plans. However, the ETF-based 401(k) landscape may likely experience significant changes in the years ahead.
The people who dictate what funds go into a 401(k) plan are supposed to be acting as fiduciaries but they may fall short of the legal standard, writes Ron Lieber for The New York Times.
ETFs, toted for their low expenses and broad market coverage, have become glaring omissions from 401(k) plans. Most employees are restricted to actively managed mutual funds that have higher costs and potentially heavier weightings in select stocks. As costs are a big consideration when planning 401{k]s, ETFs beat out mutual funds since higher costs under active management are allocated to conduct research and trade securities.
As the fate of ETFs-based 401{k} plans are tied up in U.S. bureaucracy and legal systems, individuals may begin approaching human resources or finance departments to go over the details of a company’s 401(k) plan. For starters, one may make the argument that index funds are a great addition for the employers since it will reduce the likelihood of litigation over certain fiduciary duties.
Increasing Demand in ETF-Based 401(k) Plans
Over the past five years, Stuart Robertson, general manager and principal of ShareBuilder Advisors, LLC a subsidiary of ING Bank, has helped plan ETF-based 401(k) offerings. Now, with the impending Fee Disclosure legislation that will soon go into effect, ETF-based 401(k)s are garnering greater attention. The Fee Disclosure legislation states that as of January 1, 2012, employers are obligated to offer complete transparency over what they are paying. The new rules will also allow employers to compare providers on costs and employee expenses.
Most participants are unaware that they are paying up to two or three percent out of their own pockets to cover fund expenses and management fees. As more well-established, big name brand institutions join the fray, the 401(k) market place will experience greater exposure to ETFs. [Schwab On Schedule For ETF 401(k) Launch.]
More recently, Jim McCool, executive vice president of institutional business at Charles Schwab, stated that the brokerage firm are planning out 401(k) retirement plans solely based on ETFs, reports Mary Pilon for The Wall Street Journal. Schwab will cater to companies where 401(k) plans are mainly comprised of actively managed mutual funds, since the funds have higher fees than index funds or ETFs. However, critics are warning that active trading of ETFs in 401(k)s could create higher volatility within the markets, which would cause divergences from net asset prices.
Naturally, ETFs look to be the optimal fund alternative because of their innate low costs and expenses. Additionally, research has evinced that low-expense funds have historically outperformed the high-cost mutual funds, and the performances would only compound over time. [TD Ameritrade Offers ETFs On 401 (k) Platform.]
For more information on 401(k)s, visit our 401(k) category.
Max Chen contributed to this article.