Not a week has gone by this year without someone asking me about, or talking about ETF’s for 401k plans. The conversation is always about how ETF’s are low-cost, how they are growing faster than mutual funds, how they are transparent, and just generally how great they are in 401k plans. “All 401k’s should have them”, the articles go. Major 401k vendors have announced plans to use them, and many already market ETF’s in 401k’s. Some use them exclusively. But does the hype match reality?
To review, the following are considered benefits of ETF’s to the typical investor using a brokerage account.
Now, as a review, 401k plans are a trust for the benefit of others. As a fiduciary advisor, my responsibility and obligation is to the plan, and then ultimately to the participants. The plan sponsor (the company offering the 401k) also owes an exclusive duty to the participants. So, investment selection and execution, and related fiduciary decisions matter. Yet, there is a general lack of awareness of the true costs of ETF’s and what the limitations are. And as usual for the course in 401k land, they are being over-sold by the large providers, possibly misrepresented.
Lincoln Trust Company, a leader in retirement plan custody and recordkeeping, wrote and excellent white paper discussing ETF’s in 401k’s – “401k Indexing – A Closer Look at Passive Investment Options for 401k Plans”, by Tom Gonnella. As a neutral party in the use of ETF’s, Lincoln Trust Company is in a good position to weigh in on the subject. In their study, they compare the costs of using index funds versus ETF’s in a 401k. The white paper points to the conclusion that transaction costs in ETF’s usually outweigh the benefits.
In short, ETF’s aren't any cheaper than comparable index funds, and they are usually more expensive. We'll cover more examples and comparisons in a later post.