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While many investors are flocking to exchange-traded funds (ETFs), they’re not as popular among 401(k) plan participants.
Exchange-traded funds (ETFs) emerged in the early 1990s and have since amassed about $10 trillion.
Mutual funds hold about $20 trillion, but ETFs are slowly losing their dominance. ETFs now have a market share of 32% of mutual fund assets, up from 14% a decade ago, according to Morningstar Direct data.
“ETFs are becoming a new structure used in wealth management-type accounts,” said David Blanchett, head of retirement research at PGIM, Prudential’s investment management division.
But the same enthusiasm doesn’t apply to investors in workplace retirement plans, a huge pot of largely untapped potential for the ETF industry.
According to the Investment Company Institute (ICI), 401(k) plans held $7.4 trillion at the end of 2023, with more than 70 million participants. Another $3 trillion is in other 401(k)-type plans, such as those for university and local government employees, according to ICI data.
But experts say very little of these assets are in ETFs.
“There’s a lot of money [in workplace plans]and more,” said Philip Chao, a certified financial planner who consults with companies on retirement planning.
“It’s the final frontier. [for ETFs]in the sense of trying to capture the next big pool of money,” said Chao, founder of Cabin John, Maryland-based Experiential Wealth.
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About 65% of 401(k) assets were invested in mutual funds at the end of 2023, according to ICI data. The group does not report corresponding statistics on ETFs.
Another report from the Plan Sponsor Council of America, an industry group representing employers, suggests that ETFs hold only a small portion of the remaining share of 401(k) assets. There is.
The PSCA report examines the relative popularity of investment structures such as mutual funds and ETFs in 2022 across approximately 20 investment classes, from equity funds to fixed income and real estate funds. The report found that 401(k) plans use ETFs. Sector and commodity funds do so most easily, and even then only 3% of them do so.
The main advantage is “irrelevance”
Mutual funds, collective investment trust funds and individually managed accounts accounted for the majority of 401(k) assets across all investment categories, according to PSCA data.
Such investment vehicles perform the same basic function. In other words, it is a legal structure that pools investors’ funds.
However, there are some differences.
Experts say ETFs offer certain perks for investors compared to mutual funds, such as tax benefits and the ability to trade intraday, for example.
But Blanchett said those benefits are “unrelated” to 401(k) plans.
He said the tax code already gives tax benefits to 401(k) accounts, and the advantage of ETFs over capital gains taxes is an issue.
Blanchett said 401(k) plans are also long-term accounts, and frequent trading is generally not encouraged. Only 11% of 401(k) investors made trades or exchanges in their accounts in 2023, according to Vanguard data.
Additionally, in workplace retirement plans, there is a decision-making layer between the fund and the investors: the employer.
Company officials choose which investment funds to offer to 401(k) participants. This means that ETFs may not be available to investors who need them.
Experts say there may also be technical obstacles to making the change.
The traditional infrastructure supporting workplace retirement plans isn’t designed to handle intraday trading, meaning it’s not built for ETFs, says Betterment for Work’s capital markets strategy and operations manager. said Mariah Marquardt in her 2023 analysis. Mutual fund orders placed by investors are priced only once a day, at market close.
Experts say mutual funds also have entrenched payment and distribution arrangements that ETFs cannot accommodate.
Mutual funds have different share classes. Depending on the class, the total mutual fund fees paid by investors include fees for various players in the 401(k) ecosystem (e.g., investment managers, plan administrators, financial advisors, and other third parties). may be included.
Although a mutual fund’s net fees are divided and distributed among various parties, investors rarely see these items on their financial statements, Chao said.
Conversely, an ETF has only one share class. They don’t have the ability to consolidate distribution fees, Chao said, so investors’ expenses will show up as multiple line items.
“Most people only want to have one item,” Chao says. “I feel like I don’t have to pay anymore.”
“It’s as if ignorance is bliss,” he said.
