Due to their low cost and tax efficiency, ETFs are becoming an extremely popular investment for taxable accounts. “Since March 2009, when U.S. stock markets hit their lows, investors have pumped $57 billion into ETFs holding U.S. stocks. U.S. stock mutual funds over the same period have suffered withdrawals of $66 billion, according to Morningstar Inc.”1 Due to the success of ETFs in taxable accounts, many ETF providers are making a big push to get their products into 401(k)s and other defined contributions plans.
If you are considering adding ETFs to your 401(k) plan , you should be familiar with what your recordkeeper charges for using those assets in your plan. Note: It is extremely likely that your recordkeeper will charge an additional fee for ETFs, over the use of mutual funds. Recordkeepers typically price ETFs in one of two ways:
- Asset-based fee ‘” Your recordkeeper could add an additional basis point charge to all assets in a plan that includes ETFs in its investment lineup. Thus, you would be paying slightly more in recordkeeping costs for a plan that included ETFs, rather than just mutual funds. Under this arrangement, all participants would incur higher fees, regardless of whether they are invested in ETFs or only mutual funds.
- Transaction commissions per share ‘” Your recordkeeper may charge a per share transaction fee for each ETF purchase and sale; this fee is generally debited from the proceeds of the transaction. Only participants who invest in ETFs pay the transaction commission fee. Some recordkeepers may charge a different fee based on when ETF trades are submitted. For example, if the recordkeeper submits the plan’s trades prior to market close, it may charge a discounted per share fee for each ETF transaction. However, this fee may only be applicable for purchases or sales only; i.e., if the ETF was part of an exchange with another fund, the higher fee may apply. For recordkeepers that offer same day exchanges between fund families (nearly a standard practice in the 401(k) industry), mutual fund trades cannot be submitted prior to market close. Thus, a plan with both mutual funds and ETFs would likely subject its ETFs trades to the higher per share fee. The reason: the recordkeeper will most likely submit the ETF trades at the same time as mutual funds, allowing plan participants to exchange between ETFs and mutual funds.
ETFs might be a great addition to your 401(k) plan. However, when considering the overall cost to the participant, it is important to factor in an additional fee that a plan may be charged for using ETFs as opposed to simply mutual funds. Whereas an asset-based surcharge is a very simple and transparent way for plans to determine the additional cost of using ETFs, transaction based fees are a little murkier because they depend not only on the per-share cost of the trades, but also to the trading frequency of a plan’s participants. “Buy and hold” investors will experience lower transaction costs than the frequent traders.
In summary, it is highly likely that including ETFs in your 401(k) plancan reduce your overall plan costs, allowing you to create a low cost 401(k) plan, but you should consider the additional asset-based fee or transactions fees charged by your recordkeeper in any cost analysis.
1How ETFs Have Reshaped Investing. The Wall Street Journal, April 18, 2011.