An exchange-traded fund, or ETF, is like an open-end mutual fund in that a share represents a fractional piece of a portfolio of assets. It has important differences, however, from an open-end mutual fund, in that it can trade intraday on a stock exchange in a brokerage account. Open-end mutual funds trade after the exchange closes at the fund's net asset value, or NAV, at the end of the day.
ETFs started out mimicking index mutual funds. Most still do, but ETFs with an actively managed bent now exist as well as sector ETFs, commodity ETFs and leveraged ETFs. If there's a corner of the market you want to invest in, there's likely to be an ETF that invests in that corner. ETFs have a kissin' cousin called the exchange-traded note, or ETNs.
In an article written by Trang Ho on the Institutional Investor website, "The Debate over ETFs in 401(k) Plans," she points out that Charles Schwab recently launched an ETF-only 401(k) platform and that Schwab joins ShareBuilder and TD Ameritrade in offering ETFs in their 401(k) platforms.
Launching a platform is one thing. Getting plan providers to adopt it is another. The 401(k) plans were built on a mutual fund model, and transitioning to an ETF model isn't easy. Plan providers hire plan administrators to run their plan. It can be a big deal to get a plan provider to change the mix of mutual funds available to plan participants (employees). Getting providers to offer a new type of investment is a more difficult exercise. Getting providers to change administrators also isn't easy.
The typical 401(k) plan participant has no business trading his or her account. They should be investing, not trading. But the typical 401(k) participant also has a "set it and forget it" approach to asset allocation in their plan account, and that's no recipe for success either.
What I like about ETFs is that they can provide a way for investors to hedge their portfolio within the retirement account. I like the ability to use trailing stops and limit orders to control entry points and exit points in an investment. I like the convenience of investing in alternative investments such as commodities, currencies and precious metals within the retirement account. They aren't right for everyone, and for many plan participants it would require a relationship with a trusted investment professional to help in the decision making. Ho's article also discusses potential cost savings when investing 401(k) monies in ETFs versus mutual funds, but there may be tradeoffs in plan administration costs.
Retirement investors that have 401(k) or 403(b) money with a previous employer could choose to do an IRA rollover into a brokerage account and have ETF and ETN choices available to them. As always, a trustee-to-trustee transfer, or direct rollover, is likely to be the best way to move the account.
What do you think? Do you want your employer to offer ETFs as an investment option in your 401(k) plan? Take a look at the Bankrate feature, Exchange-traded notes different from ETFs.
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