As ETFs experience record-breaking inflows, many retail investors continue to eye them for their lower costs, transparency and opportunities for niche exposure. Although they’re quickly becoming a top choice for many investors, they have yet to gain any serious within 401(k) plans.
Experts say most 401(k) platforms aren’t designed to handle the trading complexities of ETFs. Although they may offer lower expense ratios, the problems of dealing with fractional shares, intraday trading and administrative issues make them extremely difficult to manage in a ordinary 401(k) plan. As emerging 401(k) platforms emerge to address these issues, some experts say more ETFs could soon be found in retirement plans.
ETFs are rarely found in 401(k) plans because a typical plan infrastructure simply isn’t set up to handle them. Steve Dimitriou, president-elect of the National Association of Plan Advisors and managing partner at Mayflower Advisors in Boston, says a multitude of factors keep ETFs out of company retirement plans. First and foremost is the issue of intraday trading. 401(k) plans are typically designed to use contributions to buy shares of mutual funds after the close of trading day. Valuation is relatively simple because it is done once per day but because ETFs trade like stocks, their valuation changes by the second during the day.
Another problem is the issue of fractional shares. Mutual funds typically let investors buy in any dollar amount then issue fractional shares to cover the difference, but ETFs only sell in fractional shares. So a 401(k) plan participants would have to wait until they have money to reach a full share price or they’d have to leave money on the table until the next purchase. Dimitrou says it would create a massive headache for record keeping and could perhaps shortchange some investors.
But a few smaller brokerages have been offering ETFs in 401(k) plans, and the big players aren’t far behind. Schwab recently made headlines when it announced the rollout of an all-ETF 401(k) retirement platform. Built off the success of its index mutual fund plan, the platform will work around many of the issues that have traditionally made it difficult to allow the use of ETFs in retirement plans. Dave Gray, vice president of client experience for the 401(k) plans at Schwab, believes ETFs can offer unique advantages in helping participants optimize their retirement outcome by lowering costs and increasing options.
“We believe it is going to become very predominant for ETFs to be in 401k plans,” Gray says. “There is tremendous pressure to drive down investment expenses and drive up the outcomes for participants to help them have a better retirement.”
Some experts question whether ETFs can match the efficiency of mutual funds with plans and say the cost savings may not yet be a major factor. On a simple expense ratio, ETFs often have mutual funds beat but as of now, their additional trading costs, fractional share issues and complexity for employers bring in higher administrative and backend costs.