ETFs and 401(k)s

There has been a good deal of discussion about ETF's by plan sponsors. First, it is incorrect to diminish the transaction costs of ETFs in a 401(k). Every ETF transaction generates a commission. Each year there are 24 $150 deposits into the plan invested in 4 different investments for each participant in a typical 401(k). Assuming the participant does no rebalancing or other asset allocation change during the year that is 96 transactions. Investing employer contributions increases the number of transactions. If you price out the cost of the commissions generated by this process you will find it is substantial. It also adds significantly to the complexity of plan recordkeeping.

In addition, doing a cost comparison between an ETF and an actively managed mutual fund is not an apples to apples comparison. ETFs are passive in construction. When you compare the total cost including commissions between a Vanguard ETF and the equivalent Vanguard index mutual fund you will see there is not that much difference in total investment and transaction cost. So far companies that want a passive investment alternative in their plan see no added value to changing from their current index fund solution to an ETF.

ETFs are beneficial to those actively trading their accounts as they provide for greater pricing precision and their value is continually recalculated throughout the trading day. Companies who wish to provide this level of flexibility to participants provide brokerage accounts in their plans (approximately 15% of plans) and it would not surprise me if participants using their brokerage option were trading using ETFs.