Use ETFs In 401(k)s?
These risks aside, partial-share ETF trading opens up investment to the lowest-asset-base investors, encouraging market participation at younger ages.
It also makes it easy to regularly invest small amounts of cash, i.e., dollar cost averaging—such as that done through biweekly paycheck contributions. Therefore, if and when brokerages like Schwab decide to offer fractional ETF trading, it could dramatically improve the attractiveness of using ETFs in employer-offered 401(k) plans, for example.
However, trading commissions could still chip away at the utility of fractional ETF trading in 401(k)s, given that in some or many cases, a $4.95 or $9.95 buy/sell cost significantly outstrips the price of the underlying fractional ETF share. Yet the industry appears to be shifting more and more to commission-free trading; in recent months, Interactive Brokers, TD Ameritrade, E*Trade and Schwab have dropped commissions on all trades.
That said, the real solution to the aforementioned problems of cash drag and imprecise investment allocations might not be fractional ETF trading at all, but the de-bundling of securities from the ETF packaging entirely, through direct indexing.
Via fractional stock ownership, direct indexing allows investors to precisely allocate their cash to the securities of an index, without the use of any pooled investment vehicle. Until recently, direct indexing was only available to the highest-asset investors. But newer services, such as Orion, bring this technique to advisors and investors with lower and lower asset bases.
If direct indexing takes off in retirement accounts, fractional ETF trading may indeed become a true holy grail: a once-prized treasure that everybody’s given up seeking.