Why ETFs Should Be in Your 401(k)
Like getting eight hours of sleep a night and donating blood, contributing to your 401(k) is both sensible and virtuous. It’s hard to argue against ensuring your financial security in your golden years, but the retirement vehicle gets a bad rap because of expensive mutual fund fees.
So is adding exchange-traded funds (ETFs) to your retirement portfolio instead an intelligent move? There are plenty of advantages but still some draw-backs to consider.
ETFs, as a whole, are lower cost investments, a fact that allows you to keep more money in your pocket over the long-term. Expensive mutual fund fees can snowball and take away 10% or 20% of the potential portfolio you’ll tap into roughly 45 years after you start your 401(k). In fact, the average American household will pay $155,000 in 401(k)s over the course of a career, according to think tank Demos.
“It’s still a fundamental fact that no one wants to trade their retirement funding for the bottom line of a mutual fund company,” said Charles A. Ragauss, director of product management at ACSI Funds in Ann Arbor, Mich.
Compared to mutual funds, ETFs have lower fund expenses, because they tend to be passively managed funds that track a particular index, said Stephen Rischall, a 401(k) expert and founding partner at 1080 Financial Group in Sherman Oaks, Calif.
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“Furthermore, fund expenses from ETF’s do not include 12b-1 fees like mutual funds,” he added. “These 12b-1 fees are used to pay for things like marketing materials, commissions to brokers and other tertiary costs — it is also the source of revenue sharing from investments inside a 401(k) plan.” In other words, your 401(k) provider is taking a cut of the money you put into the mutual funds it recommends. That takes cash out of your retirement fund and costs you upside potential overtime that the power of compound growth can provide.
Even though we’re increasingly seeing lower-cost, passively managed index-based mutual funds, they’re still typically a few basis points more expensive than the equivalent ETF that tracks the same index. As a comparison, Rischall pointed to an ETF vs. mutual fund match-up from Vanguard.
- Vanguard 500 Index Fund Investor Share Class (VFINX) = 0.14%
- Vanguard S&P 500 ETF (VOO) = 0.04%
The mutual fund here is 0.10% more expensive than the equivalent ETF, but with other providers, the difference can go much higher.
“All other things being equal, almost any ETF has an opportunity to outperform a comparable mutual fund of similar style, simply due to a lower expense ratio,” said Kip Meadows, CEO and founder at Nottingham in Rocky Mount, North Carolina.
But gravitating toward ETFs is not just about cost.