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.
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The liquidity of ETFs demonstrates their ability to be tactically maneuvered between specific asset classes when prompted by changes in the market. Since ETFs are traded like stocks on an exchange, they can be bought and sold at their intraday value. This allows for quick, strategic changes in portfolio allocation without having to wait for market close. The option to alter your allocation preferences at a moments notice adds to the appeal of an ETF-based plan.
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. Evolving technologies are enabling financial companies to make ETFs more available to investors, while at the same time, employees are requesting a more complete menu of funds to choose from when selecting 401(k) investments. ETF availability paired with heightened employee demand for retirement plan options provides a prime foundation for all-ETF 401(k) plans to establish themselves within the market.
Duncan Rolph is a partner and managing director at
