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Honk if you love ETFs!

By Dr. Don Taylor ·
Monday, September 30, 2013
Posted: 6 am ET

Exchange-traded funds, or ETFs, are becoming more widely available in employer retirement plans. These funds were originally structured as substitutes for popular index mutual funds. Two important differences with ETFs held in tax-advantaged retirement accounts are that they can be traded intraday when the stock market is open, and investors pay brokerage commissions on the trades -- unless those commissions are waived.

It's a given that the typical employee shouldn't be day trading his or her retirement account. But with mutual funds requiring minimum holding periods, and with minimum time periods imposed before you can repurchase a fund, ETFs can offer some advantages to the mutual fund model.

I broke bread recently with a woman who is retired from a regional bank where she was its chief investment officer. She told me that she doesn't worry about the market crashing in her retirement accounts because most of her investments are in ETFs and there are standing, or good-till-canceled, orders in place on the ETFs that will take her out of these positions should there be a selloff in the investment. Plans that only offer mutual funds don't have that type of flexibility.

ETFs have morphed from their original design as proxies for indexed mutual funds. There are now a multitude of ETFs, and their sister structure exchange-traded notes, or ETNs, that allow investors to pursue more active management strategies in their portfolios, versus the passive investment approach of an index ETF or mutual fund. An active investor tries to beat the market. The passive investor is satisfied to earn the market return on an index, less any applicable fees or expenses. Studies have consistently shown that employees don't do a very good job with active management in trying to time the market or take on other investment strategies to try to beat the market.

There are some exciting active management options with ETFs, but these structures as a means to hedge the market risk in your portfolio really haven't proven themselves long term. Still it's an easy way to add commodities, such as gold or oil, to your retirement plan's portfolio. And it's a way to make a play in foreign currencies if you think the dollar is headed for a fall. I think there's room in most retirement portfolios for a small measure of speculative risk. ETFs and ETNs give investors a range of investment choices not easily matched by the mutual fund industry.

Beware, though, that ETFs and ETNs can have high expense ratios. They may have tax advantages over a mutual fund, but that may not be relevant in a tax-advantaged retirement account. When in doubt, read the prospectus and consult with your tax and financial professionals. For the typical retirement plan participant, many of these investments are not do-it-yourself choices. Don't swing for the fences; you'll only tear your rotator cuff.

The most popular ETFs

Danielle Andrus, managing editor of Investment Advisor magazine, just wrote a piece listing the top 20 ETFs based on their distribution in 401(k) plans, according to BrightScope, a financial information company. Funds with an asterisk following their trading symbol are new to the list this time around. These are not investment recommendations. It just shows you a listing of popular ETFs in retirement accounts.

  1. Vanguard Total Bond Market (BND)
  2. SPDR S&P 500 (SPY)
  3. iShares Russell 2000 Index (IWM)
  4. Vanguard Total International Stock (VXUS)*
  5. iShares Russell 1000 Value Index (IWD)
  6. iShares Core Total US Bond Market (AGG)*
  7. iShares Russell 1000 Growth Index (IWF)
  8. Vanguard S&P Small-Cap 600 Index (VIOO)*
  9. iShares S&P 500 Index (IVV)*
  10. Vanguard Small-Cap Growth (VBK)
  11. iShares MSCI EAFE Index (EFA)*
  12. Vanguard Value (VTV)*
  13. iShares iBoxx $ Investment-Grade Corporate Bond (LQD)*
  14. SPDR Gold Shares (GLD)
  15. Vanguard S&P 500 (VOO)*
  16. iShares Russell Mid-Cap Value Index (IWS)
  17. iShares Barclays TIPS Bond (TIP)*
  18. Vanguard REIT Index (VNQ)*
  19. iPath Dow Jones-UBS Commodity Total Return (DJP)*
  20. iShares S&P MidCap 400 Index (IJH)*

I've taken the occasional position in an ETF/ETN in my IRA accounts, although I don't currently have any current holdings.

Does your retirement plan offer ETFs as an investment choice? If it doesn't, do you think it should? If it does, do you own any?

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