In this installment of our Retirement 101 blog series, we’ll talk about why exchange-traded funds, or ETFs, may have been slow to appear in 401(k) plans.
ETFs offer a number of benefits that can make them extremely attractive to investors—and well-suited for 401(k) plans in particular. One such feature is the low fees and no sales loads. While this may not seem like a big deal, even a 1% difference in fees can have a significant impact on portfolio balance over time. Additionally, ETFs offer transparency, diversification and other elements.
So, why was the 401(k) industry so slow in adopting them? There are a number of reasons. Consider the following:
• Some of the very features that make ETFs attractive to investors made them unattractive to record-keepers. As we discussed, many ETFs have low fees. While this can be a benefit for plan sponsors and their participants, in the past it was a drawback to record-keepers, as ETFs do not offer revenue sharing.
• When markets are doing well, people and institutions follow the “if it ain’t broke, don’t fix it” philosophy. Mutual funds were the 401(k) investment vehicle of choice for many years, and most people thought there was no reason to change that. But as markets unwound in 2007-2008—and as the industry started focusing increasingly on fee disclosure and other issues—record-keepers and custodians have become more interested in ETFs due to their lower fees and transparency of holdings.
• Since ETFs trade like stocks, fractional share purchases were an issue, but this has mostly been solved with executional parties.