Vanguard’s King Sees No Future For ETFs In 401(k)s

The defined contribution space is growing well, and improving retirement prospects for millions of Americans. But it’s doing that without the use of ETFs.

Reviewed by: Cinthia Murphy
Edited by: Cinthia Murphy

Defined contribution retirement plans—such as 401(k)s—are a $6.7 trillion market today, covering some 90 million working Americans. Vanguard manages about $800 billion of those assets. That market has grown and improved significantly in the past decade, Vanguard Managing Director Martha King says, but there’s plenty of room to improve. What there doesn’t seem to be is a whole lot of demand—or use—for ETFs. You took the leadership role at Vanguard's Institutional Investor Group about a year ago, working directly with employers offering retirement plans. What have you learned about how people invest for retirement?

Martha King: I’ve learned that the state of the defined contribution system is strong. There have been many positive changes that have occurred in the past decade for 401(k) plan participants. As a result, they’re better prepared for retirement. There's a lot that's going well in defined contribution plans. More specifically, it's been 10 years since the Pension Protection Act became law. It was meant to help secure retirement for workers. How has the defined contribution, 401(k) space changed?

King: The big picture is that the law propelled plan sponsors to consider changes to plan design that really were in the better interests of their employees—changes that affected the investment lineups; changes that affected the benefits of encouraging employees to participate, and to increase their contribution once in the plan. You'll hear people talk about the autos—auto-enrollment, auto-escalation—and those things really didn't exist in a meaningful way before the Pension Protection Act.

With respect to investment lineup differences, the protections afforded plan sponsors led to changes in product offering that have, in turn, many more employees now putting their assets in a balanced portfolio. Go back 15 years, you'd see a lot of employees putting money as a default in a money-market-type fund, which is certainly a safe investment, but not the way you'd want someone to invest for retirement. This law prompted better investment solutions in these retirement plans. What exactly are employers required by law to offer?

King: Plan sponsors get additional protections by putting a default investment option in place that meets several requirements—requirements that a money market fund would not meet. Before, plan sponsors would offer a long list of investments. Today, many have a default option, which in many cases is a target-date fund, or a series of target-date funds. The next layer of investment available oftentimes is an index tier. And then some plan sponsors have an active tier beyond that.

The point is that they’re trying to make it easier for participants to digest the choices they have in front of them. It's not just what investments are available, but their structuring and their presentation to participants. All of that helps get investors invested. By offering a default target-date fund, employers are taking on the responsibility in terms of deciding what investments are appropriate for an employee. That seems counterintuitive in an era of do-it-yourself investing, and robo advisors.

King: Yes. I worked in the institutional division many years ago, before I started to run the Financial Advisor Services business for Vanguard, which I did for 13 years. And you’d have to go back quite some time now, say 15 years, but there was a belief that, with a long list of investment options and great participant education, you could get employees to make the right choices to have a diversified investment portfolio.

But what we've learned is that's not necessarily so. Actually, great plan design is a much better predictor of employees having appropriately diversified investment portfolios than abundance of product choice.

The beliefs that were once held in the defined contribution space are not held so dearly today. And I think employees are absolutely better off for it. But you're right, it is different from what you'll hear conveyed at the retail market. What’s the biggest challenge to retirement investing today? Is it difficult to get employers to design great retirement plans?

King: We find plan sponsors are very receptive to discussions of better plan design, because we can come to that conversation armed with a great amount of data. It's pretty compelling.

But there's an opportunity for us as an industry, with respect to defined contribution plans, when it comes to coverage. It could be better. There are groups of individuals across the U.S. who are not covered today by a defined contribution plan either because of the size of the employer they work for, or the nature of what they do for a living.

Another issue is the savings rate. There’s been progress made where we see savings rates rising among plan participants. But there's room to grow. We would suggest that an individual have a savings rate of 15%. And that accounts for not just their own contribution, but their employer contributions as well. That’s not where the 90 million employees in DC plans are today. How do you measure the performance of a DC plan? How do you know if your retirement plan is working?

King: We have a proprietary diagnostic tool that we use in institutional here. It's a plan evaluation index that we’ve created. We’ll score the plan, and we'll talk to the plan sponsor about our findings. Much of it has to do with plan design, as you would imagine. But it also has to do with participants' uptake.

In some cases, we see plan sponsors now doing annual re-enrollments to increase uptake. When they do an annual re-enrollment, they’ll re-enroll the participant into target-date funds. The participant has the option to reallocate the assets if they so choose, but what that annual re-enrollment does is captures any employees who have not been participating in the plan and brings them in. They can opt out.

It also takes those who may be investing poorly, not in a diversified way, and get them into a diversified investment solution. Are fees playing a bigger role in retirement investing? These diversified target-date funds are also, typically, lower cost than many other investment options, right?

King: The popularity of target-date funds is happening for an important and relevant reason. It's because it gives the kind of diversification employees need in these plans. But the other aspect is continued focus on what a plan sponsor, and therefore employees of that plan sponsor, are paying for the investments. They are much more focused on fees and fee transparency than ever was the case, say, a decade ago. That's good news for plan sponsors and their employees. It's a concept that wasn't getting as much attention historically.

On a different note, I guess to some people, the nature of investment options in defined contribution plans can even look a bit boring. But remember, we're trying to invest for the needs of a very diverse audience in these defined contribution plans. An employer has an obligation to meet the needs of everything from the person who is maybe operating machinery in the warehouse to working on the line to their senior-most executives. And they are obligated to equally meet the needs of those folks.

So I don't expect a lot of interesting stories to tell when it comes to investment products, per se. I think the bigger development comes in the nature of services for employees, ranging from advice for those who need it, to something less than advice, in the form of guidance, to maybe a one-time plan, to people who may need broader financial wellness help, which takes you a bit outside of the plan. That’s where a lot of innovation in this space has focused on—services. Have ETFs carved any significant inroads into the 401(k) space? Or will this remain a big mutual fund playground?
Remember that many of these plan sponsors are so large that they're able to get pricing into institutional share classes of mutual funds that are priced below the expense ratio of an ETF.

That said, there are plenty of plans that aren't that big. And in the solutions that we provide for small plans through a third-party record keeper, ETFs can become more a part of the equation in that environment. We call it Vanguard Retirement Plan Access (VRPA). Are fees the driving reason why a plan would choose to include ETFs? Are any of the benefits of the ETF structure interesting in a defined contribution plan?

King: For a defined contribution plan, I would argue not so much. There's recurring purchases in the form of biweekly contributions, and maybe loan repayment purchases coming into the plan. These can generate additional cost and additional risk in terms of the bid/ask spread on an ETF, and those are costs and risks you wouldn't incur in buying a traditional mutual fund.

And the trading flexibility is going to be a lot less important to a defined contribution plan than, say, a retail investor. How much of Vanguard’s $800 billion in defined-contribution-plan assets are in ETFs?

King: It's a very small percentage. They are available in our small business 401(k) service—the VRPA—however, even there, there's not a huge uptake. Only about 11% of VRPA plans offer ETFs in their lineup, and less than 9% have any assets in ETFs. So the whole idea that 401(k)s are the next big frontier for ETFs is really no more than a dream.

King: I've been in the ETF game since the earliest days, and I've heard that for a long time. What I would say is, I'd think hard about who I hear it from. And it tends to be from firms that are mostly or exclusively ETF managers.

I don't begrudge their interest in the defined contribution market, because it’s a big market, but the ETF products and features that are so important and attractive to certain kinds of investors are just a lot less relevant in a defined contribution plan structure.

And that's coming from a company that has ETFs and traditional mutual funds. If we thought ETFs had a meaningful and important place in this space, we would certainly be stepping up to that, because we offer them as well as traditional funds.

So I'm a bit of a skeptic, honestly, that it really is a big new frontier for ETFs. Any other big takeaways when you think about retirement investing? The notion that there’s a brewing retirement investing crisis in this country, perhaps?

King: This notion that we're in a crisis with the retirement plan system is not an accurate characterization. I've heard it from a variety of people. It's not an accurate portrayal, because defined contribution plans are the best they've ever been. Some of the regulatory changes that have occurred in the past decade have helped propel that to a current state that looks really healthy.

Again, the big opportunity for the industry going forward is in coverage for those Americans who don't have access to a defined contribution plan today. Those without an employer-sponsored plan could in theory own the same target-date fund by going directly to, say, Vanguard.

King: They surely could. They could set up an account that would have some amount of tax efficiency to it, and use target-date funds as the underlying investment. But it wouldn't match the benefits that are available in a defined contribution plan on a tax-deferral basis. Increasing coverage in DC plans is the real opportunity.

Contact Cinthia Murphy at [email protected].


Cinthia Murphy is head of digital experience, advocating for the user in all that does. She previously served as managing editor and writer for, specializing in ETF content and multimedia. Cinthia’s experience includes time at Dow Jones and former BridgeNews, covering commodity futures markets in Chicago and Brazil equities in Sao Paulo. She has a bachelor’s degree in journalism from the University of Missouri-Columbia.