Mutual Funds Vs. ETFs In Retirement

September 23, 2019

 

Fractional Shares
Another factor in mutual funds’ favor is this structure allows fractional share purchases, while ETFs can only be purchased in whole shares, Friedman and Powers note. Since 401(k) participants are usually sending in specific dollar amounts every paycheck because of automatic investing, it’s easier to divvy up a mutual fund to match that monetary figure.

“Within a mutual fund, if the client wants to stay fully invested in whatever strategy—be it fixed income or equity markets—the mutual fund enables that very easily,” Powers said.

Where ETFs Excel
ETFs have benefits. Towarnicky notes the dramatic fall in fees for index funds works in ETFs’ favor, especially for people who choose growth and international stocks.

Powers points out the big 401(k) plans that use institutional share class pricing have access to lower expense ratios, but in smaller plans without access to institutional share classes, or in collective trusts, ETFs could be the cheaper option versus a conventional investor class.

Plus, there’s the daily transparency of ETFs versus mutual funds that favors ETFs, Towarnicky adds.

Target-date funds hold the bulk of 401(k) assets, being the default setting for many plan sponsors, Powers notes, and there aren’t many ETF options similar to this structure. Mike Dickson, head of portfolio management at Horizon Investments, says that could change.

Target-date funds put users on a glide path to retirement, automatically tweaking the mix of stocks and bonds as the holder nears retirement. Dickson believes ETFs can do the same, but better.

His firm handles ETF managed accounts for many clients, and believes these could be a good alternative to target-date mutual funds in 401(k)s. These could allow for more tailored account management that not only accounts for retirement age, but also the client’s desired spending rate in retirement.

“We could adjust the asset allocation accordingly,” Dickson said. “I feel that’s taking it one step further.”

IRAs See More ETF Usage
When it comes to IRAs, ETFs are gaining ground. ICI data showed IRA assets totaled $8.8 trillion at year-end 2018 (see Figure 1), accounting for 33% of U.S. retirement assets, with mutual funds comprising 45% of IRA assets. The other 44% were made up of ETFs, closed-end funds, individual stocks and bonds, and other non-mutual fund securities held through brokerage accounts.

 

For a larger view, please click on the image above.

 

The ICI data notes ETF-owning households are more likely to own IRAs than households that own mutual funds and individual stocks, and they have higher educational levels and greater financial assets (see Figure 2).

 

For a larger view, please click on the image above.

 

Friedman says that it makes sense to see ETFs making inroads in IRAs: “People are more in control. You don’t necessarily have to have a plan sponsor dictating to you what products are available.  . . . And there are a lot of third-party [retirement] models out there that use ETFs.”

ETFs may make further inroads into 401(k) plans, but it will be gradual, as Towarnicky observes that changes in retirement savings are evolutionary.

“Most plan fiduciaries and plan sponsors are not first movers, or even fast followers,” he said.

Friedman acknowledges that customers and clients are changing, and that could change retirement savings: “I think what customers are looking for in terms of their advice and solutions and strategies are changing. So I think the 401(k) market will eventually change with it.”

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