Since 401(k) plans were launched more than three decades ago, mutual funds have been the vehicle of choice for investors using these employer-sponsored plans. The road to retirement planning paradise, however, has not been free of potholes for ETF distributors looking to cut in on the long-standing marriage between mutual funds and 401(k)s.
Still, ETF providers are making some inroads toward encroaching upon the dominance of mutual funds in 401(k) plans and with good reason.
“Although mutual funds have historically been the core investment vehicle associated with 401(k) plans, various financial companies are beginning to offer the option of 401(k) plans comprised solely of ETFs. The transition to ETF-based 401(k) plans will not occur overnight due to the established popularity of mutual funds, but ETFs are positioned to develop a strong presence with such plans in the coming years,” writes Duncan Rolph of Miracle Mile Advisors in a piece published by Employee Benefit News.
Recent data indicate ETFs are gaining traction in retirement plans. The most recent Charles Schwab Self-Directed Brokerage Account (SDBA) Indicators report shows more self-directed investors are allocating retirement assets to ETFs.
“According to the Schwab data, exchange-traded funds were the only investment category to see an increase in net asset allocation year-over-year. Asset allocations in mutual funds held steady in the quarter, comprising 41 percent of overall portfolio allocation. Allocations in individual equities remained unchanged at 25 percent while SDBA participants decreased their cash positions to 18 percent,” said California-based Schwab. [Schwab Says ETFs Gaining Retirement Assets]
Rolph notes in the Employee Benefit News piece that ETFs offer advantages over mutual funds, including lower fees and steadier, passive management.
“ETFs track steady indices instead of gambling on the stock choices of fund managers. Funds that are actively managed include management fees and often underperform the market, while ETFs can offer greater performance at a nominal cost to the investor,” according to Rolph.
While some critics claim many employees have access to low-cost index mutual funds in their 401(k)s and that there is no need to offer ETFs in the plans, that assertion ignores key differences between “many” and “most.” That assertion also glosses over the advantages of ETFs and obvious investor demand for accessing the products in 401(k) plans.
Some companies are already meeting that demand. TD Ameritrade (NasdaqGM: AMTD) is already offering ETFs to the 401(k) world and has been doing so for nearly three years. [TD Ameritrade Solves ETF/401(k) Riddle]
Earlier this year, Schwab Retirement Plans Services made 80 ETFs from 11 providers available in its new 401(k) ETF platform. In addition to Schwab ETFs, plan participants can choose from ETFs offered by ETF Securities, First Trust, Guggenheim Investments, Invesco PowerShares, iShares ETFs, PIMCO, State Street Global Advisors, Van Eck Global, Vanguard and United States Commodity Funds. [Schwab Launches 401(k) ETF Program]
A 401(k) plan using index exchange-traded funds can reduce investment expenses by more than 90 percent compared to a typical 401(k) plan that primarily uses actively managed mutual funds, and by more than 30 percent compared to a 401(k) plan that uses index mutual funds, said Steve Anderson, head of Schwab Retirement Plan Services, when Schwab unveiled its plans to bring ETFs to 401(k) plans.
“The combination of technological advancements and individual demands has positioned investors to migrate away from the traditional 401(k) plan towards an option that is better suited for the modern investment environment,” added Rolph in the Employee Benefit News article.
ETF Trends editorial team contributed to this post.