While ETFs have morphed from thorn in the side of mutual funds
to legitimate competitor, one area where the former has made few
inroads against the latter is in 401(k) plans. When 401(k) became
part of the retirement lexicon in the 1980s, ETFs were not around
and the retirement plans were constructed in part to accommodate
mutual funds.
Until now, mutual funds have dominated the 401(k) arena, but
with new disclosure requirements on the horizon, investors may
start clamoring for ETFs to be made available in 401(k) plans.
The new requirements are aimed at highlighting fees beyond basic
fund management, including fees they charge for distribution,
marketing and other costs, and increasing transparency.
ETFs have a long way to go when it comes to defined
contribution plans in the U.S., a market in which ETFs control
just one percent of the assets,
according to Bloomberg
. That does not diminish the cost argument, though.
"By design, ETFs offer daily transparency of holdings1 as well
as transparency of fund management costs," said Sean Kelly,
WisdomTree director of retirement services, in a research note
published by ETF sponsor WisdomTree. Since ETFs do not carry
bundled fees or revenue sharing, "they are already aligned with
the new requirements on fee disclosure. With ETFs, you always
know what you own and what you paid for it. So, as far as your
late-October account statements-no surprises."
Citing Labor Department data, Kelly notes there currently are
an estimated 483,000 individual retirement account plans out
there, covering roughly 72 million participants. However, many
employers already offer low-cost index funds as part of their
401(k) options, so there is some burden on ETF sponsors to cost
savings.
ETFs do offer superior cost advantages when compared to mutual
funds and it is what often appear to be small differences in
costs that can
significant impacts on returns
. Even savings of just 20 or 30 basis can a major impact over
long-term time horizons, which retirement accounts are obviously
geared toward.
"Let's say your initial investment is $25,000. If we are
comparing apples-to-apples, hypothetically, your return should be
7.5%, but because of the additional 1% in fees, the net return is
6.5%," wrote Kelly. "In the higher-fee scenario, over the course
of 20 years a $25,000 investment with a 6.5% return will grow to
about $88,091.13. But in the lower-fee scenario, a $25,000
investment with a 7.5% return will grow to about $106,196.28 over
the same amount of time."
There are other issues regarding ETFs moving into the 401(k)
arena. Mutual fund shares are traded in batches at the end of the
trading day through a clearinghouse that charges a small fee, but
ETFs trade through traditional brokers that charge commissions
based on share size,
the Wall Street Journal reported earlier this
year
.
That brings up the issue of allowing participants to trade
ETFs in 401(k) plans intraday or barring them for doing so ETF
trades could be packaged in the same fashion as mutual fund
trades.
Some companies do see the allure of ETFs in 401(k) plans.
Charles Schwab (NYSE:
SCHW
) is working on all-ETF 401(k) product. Capital One's (NYSE:
COF
) ShareBuilder 401(k) plan features ETFs and nothing else, the
Journal reported.
ETFs clearly have a long way to go become a force in the
401(k) universe, but investors in small 401(k) plans that are
often subject to higher fees might make this dream a reality for
ETF sponsors.
For more on ETFs and fees, click
here
.
(c) 2012 Benzinga.com. Benzinga does not provide investment
advice. All rights reserved.