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Although many investors flock to As for exchange-traded funds, they haven’t made much headway among 401(k) plan participants.
Exchange-traded funds (ETFs) debuted in the early 1990s and have attracted approximately $10 trillion in capital.
Mutual funds hold about $20 trillion, but ETFs have eroded their dominance: ETFs have a 32% market share relative to mutual fund assets, up from 14% a decade ago, according to Morningstar Direct.
“ETFs are becoming the new structure used in wealth management-type accounts,” said David Blanchett, director of retirement research at PGIM, the investment management arm of Prudential.
However, the same enthusiasm cannot be said for investors in workplace retirement plans, a huge untapped potential for the ETF industry.
As of the end of 2023, 401(k) plans held $7.4 trillion, according to The Investment Company Institute (ICI) has more than 70 million participants. Other 401(k)-type plans, such as those for college and local government workers, hold an additional $3 trillion, ICI data shows.
But experts say almost none of these assets belong in ETFs.
“There’s a lot of money (in workplace plans) and there’s going to be more,” said Philip Chao, a certified financial planner who advises companies on retirement plans.
“This is the final frontier (for ETFs) in the sense of trying to capture the next big pool of money,” said Chao, founder of Experimental Wealth in Cabin John, Maryland.
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About 65% of 401(k) assets were invested in mutual funds as of the end of 2023, according to ICI. The organization does not report corresponding statistics for ETFs.
A separate report from the Council of Plan Sponsors, a trade group representing employers, showed that ETFs hold only a fraction of the remaining share of 401(k) assets.
The PSCA report examines the relative popularity of investment structures such as mutual funds and ETFs in 2022, across about 20 investment categories ranging from stock funds to bond and real estate funds. Easiest to do so – but even then, they only do it 3% of the time.
Key benefits “irrelevant”
mutual funds, collective investment trust fund PSCA data shows that separately managed accounts account for the largest share of 401(k) assets across all investment categories.
These investment vehicles have the same basic function: they are legal structures that pool investors’ money.
However, there are some differences.
For example, ETFs offer certain benefits to investors over mutual funds, such as tax benefits There is also the ability to day trade, experts say.
Blanchett said, however, that these benefits have “nothing to do” with the 401(k) plan.
He said the tax code already gives 401(k) accounts favorable tax treatment, which renders the advantages of ETFs over capital gains taxes moot.
Blanchett said 401(k) plans are also long-term accounts and often discourage frequent trading. According to Vanguard, only 11% of 401(k) investors made trades or redemptions in their accounts in 2023.
Additionally, in a workplace retirement plan, there is one decision-making layer between the fund and the investors: the employer.
Company officials choose which investment funds are offered to 401(k) participants — meaning investors who want ETFs may not be able to get them.
Experts say there may also be technical barriers that need to change.
Mariah Marquardt, manager of capital markets strategy and operations at Betterment for Work, wrote in a 2023 report that the traditional infrastructure underpinning workplace retirement plans was not designed to handle day trading, meaning it was not built for ETFs analyze. Investor orders for mutual funds are priced only once each day at the close of trading.
Mutual funds also have entrenched payment and distribution arrangements that ETFs cannot adapt to, experts say.
Mutual funds have many different share classes. Depending on the category, the total mutual fund fees an investor pays may include fees from many different players in the 401(k) ecosystem: such as investment managers, plan administrators, financial advisors and other third parties.
Net mutual fund fees are allocated and allocated to various parties, but investors largely don’t see these items on their account statements, Zhao said.
In contrast, ETFs have only one share class. Zhao said they don’t have the ability to bundle these distribution fees together, meaning investors’ fees show up as multiple line items.
“Many people like to own only one item,” Zhao said. “You feel like you don’t have to pay anything anymore.”
“It’s almost like ignorance is bliss,” he said.
