ETFs Seek Breakthrough in 401(k) Plans

Adding ETFs to retirement plan menus is seen as inevitable.

Jeff_Benjamin
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Wealth Management Editor
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Reviewed by: etf.com Staff
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Edited by: James Rubin

It is probably only a matter of time before ETFs become staples of 401(k) plan menus. 

But for now, the fastest-growing investment product is largely snubbed when it comes to tapping into the more than $7 trillion retirement plan market.

“The majority of innovation in asset management is happening in ETFs, and I have to believe that as a plan sponsor it has got to be increasingly difficult to justify not even considering ETFs,” said Amrita Nandakumar, president of Vident Asset Management in Alpharetta, Ga.

While there are examples of ETFs being included among the investment options on employer-sponsored retirement savings plans, the practice remains rare as the 401(k) and comparable programs are still dominated by mutual funds.

The reasons ETFs have a hard time breaking through on plan menus range from logistical to legal, and always tilt toward what is best and easiest for retirement savers.

“When you’re looking at the legacy giants of 401(k) plans, they’ve been around a long time and that means the backbones of the operations are built for mutual funds,” said Jarrod Sandra, owner of Chisholm Wealth Management in Crowley, Texas.

“When you’re looking at a company like Fidelity, you’re talking about 20,000-plus plans that you have to build the option for ETF’s,” he added. “That’s a huge undertaking and cost burden in an environment that has seen fee compression over the past decade.”

ETFs Jockey for 401(k) Shelf Space

A migration toward ETFs would certainly hit the bottom line of legacy mutual fund companies that control so much shelf space in the retirement plan market.

But on that note, Sandra offers a counterpoint to the fee debate.

“You have mutual fund options that can rival some ETFs in price,” he said, citing the Fidelity 500 Index mutual fund (FXAIX), which charges just 0.015%, or double the 0.03% expense ratio of the Vanguard S&P 500 ETF (VOO).

Most recordkeepers and plan sponsors offer retirement savers the option to invest in ETFs through a self-directed brokerage account, which requires a few more steps and a bit more investor savvy.

“They aren’t always closing the doors to ETFs; you just have to walk through a different door and your plan has to allow for it, which is an additional expense to both the plan and participant usually,” Sandra said.

Matt Kaufman, head of ETFs at Calamos Investments in Naperville, Ill., makes the point that many of the advantages of investing in ETFs are diminished when wrapped inside a qualified retirement account.

“ETFs have become an investment vehicle of choice largely due to their tax-efficiency, liquidity, and lower costs, all of which become minimized inside many tax-advantaged retirement plans,” he said. “The lower operational expenses of ETFs and the vehicle's overall lower fees versus the mutual fund, however, may still be advantageous.”

Cases have also been made against including ETFs on retirement plan menus because they trade throughout the day like stocks—unlike mutual funds that trade just once per day.

Michelle Ross Cannan, managing director and head of retirement plan services at Modern Wealth Management in Rochester, N.Y., said that on many of the 401(k) platforms that include ETFs, the trading is restricted to daily to be in sync with mutual funds on the platforms.

That’s just one of the nuances that can be introduced when adding ETFs, she added.

“Plan participants who are avid investors may see the ETF acronym in a fund name and believe that a requested trade will take place on-demand instead of at the end of the day,” Cannan said. “This could cause confusion and concern amongst 401(k) plan participants regarding the price that is used when trading plan investments and presents a challenge for plan sponsors who know there may be a risk of market declines taking place between when a participant requests an ETF trade and when the market closes.”

On the fee debate, Cannan said the potential savings when shifting to ETFs from mutual funds would likely amount to less than 0.02%.

Patrick Fontana, founder of Fontana Financial Planning in Dallas, manages a number of 401(k) plans that include ETFs as an investment option, and he said the biggest challenge is the automatic investments each pay period.

“This differs from a standard mutual fund 401(k) where each contribution is buying a defined percentage but not necessarily rebalancing,” he added. “That said, the friction there is very light, and we have prebuilt models that allow us to rebalance the account with each contribution.”

Jeff Benjamin is the wealth management editor at etf.com, responsible for coverage related to the financial planning industry. This includes writing, hosting podcasts, webinars, video interviews and presenting at in-person events.


Jeff is a veteran journalist with more than 30 years’ experience covering the financial markets. He has won more than two dozen national and regional awards for his reporting. He most recently worked as a senior columnist at InvestmentNews where he wrote about investment products and strategies, as well as the broader financial planning industry. Prior to that, Jeff worked as an analyst at Cerulli Associates where he researched and wrote reports on the alternative investments industry. Jeff also worked as a money management reporter at Dow Jones Newswires, where he covered the mutual fund industry.


Based in North Carolina, Jeff is a former Marine and has a bachelor’s degree in journalism from Central Michigan University.