Having recently gained momentum in the investment world, exchange-traded funds carry a large amount of excitement. They commonly offer lower expense ratios and higher liquidity when compared to mutual funds while still providing diversification through broad exposure to all asset classes. 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.
ETFs and mutual funds share many similarities at first glance, but the exceeding benefits of ETFs shine through when the two are further broken down and analyzed. ETFs offer much lower expense ratios than mutual funds due to the fact that they are index-based funds and therefore not actively managed. The average actively managed mutual fund charges an annual fee of 1.39%, while the average ETF charges just 0.21%. As 401(k) funds cumulate for several decades, the expense ratios have an immense impact on the total net returns of the portfolio. Also, 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.
