|ETFs making headway in 401(k)s
"The average cost of using our software for these
models varies from 25 basis points at a low to 45 basis points at
a high, versus the average lifestyle fund, which has an expense
ratio of over 100 basis points and the average equity fund, which
is 150 basis points."
But ETFs are getting the cold shoulder from many in
the 401(k) industry, especially larger
companies that might qualify for low, institutional expense ratios.
"The 401(k) investment
approach is pretty settled," says David Wray, president of
the Profit Sharing/401(k) Council of America.
"They use a mutual fund-type program and companies are reluctant
to change a system that's working well. Companies aren't looking
to add new alternatives. In fact, they're talking about reducing
the number of alternatives. At one point more was seen as better,
but that's no longer the case."
Vanguard, the giant fund company, makes its ETFs available
to retirement plans through Abrahamson's Invest n Retire, but doesn't
include them in Vanguard's 401(k) plans
that don't have a brokerage option.
"If it's not broke don't fix it," says Noel
Archard, principal with the Vanguard Financial Advisors Group. "Operationally,
the 401(k) market grew up around the mutual
fund structure. It's not really meant for something that trades
like an individual security. We have seen some funds trying to tackle
this issue, but there's not always a clear expense ratio advantage.
Some 401(k) plans qualify for institutional
share expense ratios, and for a comparable benchmark it might be
lower than an ETF.
"It's something that's in the early days and
there's some evolutionary work to be done. It has to make sense
for the participant. There are plenty of diversified, low-cost products
An interesting aspect of the newly enacted Pension
Protection Act of 2006 is that employers are encouraged to automatically
enroll workers in defined contribution plans and increase the employee's
contribution annually. When an employee is automatically enrolled
in a 401(k) someone else has to choose
the investment options for them. Wray says ETFs could be attractive
as the default.
"We're moving from a system where more choice was good to one where the predominant choice will be the employer-determined solution. It's a 180 degree turn. The point is that in the future the move to a default approach will have an impact on what's utilized as an investment option in 401(k) plans. There has to be a catalyst for change and this is a big one."
It's estimated that up to 30 percent of eligible employees
don't sign up for 401(k) plans. Wray's
Profit Sharing/401(k) Council of America
is a nonprofit association of companies that sponsors more than
1,100 profit sharing and 401(k) plans
for more than 6 million employees. Wray says 10.5 percent of the
companies had automatic enrollment in 2004 and that percentage jumped
to almost 17 percent in 2005.
Perhaps not all employees can expect access to ETFs in their 401(k) soon, but if you work for a small company with a 401(k) plan that's weighed down by fees, talk to your employer about ETF options.
Everyone who participates in a defined contribution
plan should be well-aware of the fees. If you're paying expense
ratios of 1.5 percent to 2 percent for equity funds, it might be
time to look at alternatives.