Article - ETFs Make Inroads into Retirement Plans

As sponsors attempt to reduce fund expenses, the product becomes more attractive.

By Abigail E. La Croix

ETFs Make Inroads into Retirement PlansAs sponsors attempt to reduce fund expenses, the product becomes more attractive.By Abigail E. La CroixOctober 28, 2004- The financial services market has seen net assets that flowed into ETFs during the first three-quarters of 2004 skyrocket to over $30 billion, according to Morgan Stanley research. And the universe of 166 index-linked ETFs with total assets of over $190 billion and average daily trading volume of over $11 billion (204 million shares) continues to grow at a dramatic pace.

Many retirement plan sponsors, beginning to feel the pinch associated with the cost of managing 401(k) plans, have begun looking at ETFs as an alternative means to lowering expenses while offering greater trading flexibility, tax efficiency, and diversification.

"ETFs may be a good fit for smaller firms that don’t have leverage to drive down fees," said Pamela Hess, defined contribution consultant at IL-based Hewitt Associates. Generally fund expenses are three-quarters of the cost of 401(k) plans. And higher fees can negatively impact returns when compounded over time, she said.

"If employers don’t manage the total plan cost effectively, employees’ total retirement earnings could be reduced by hundreds of thousands of dollars over time, as higher management costs cut into their total investment returns."

For example, consider a 35-year-old employee with a balance of $100,000 in his 401(k) plan, who does not make any additional contributions, with assets growing at a rate of 8% per year gross of fees. If the plan has fees of 1.5%, the employee’s 401(k) balance would be $660,000 in 30 years. But if the employee’s plan fees were reduced by just 0.5%, his 401(k) balance would increase by nearly 33% to $875,000.

While some firms, including Ameritrade and Sharebuilders.com through an arrangement with SAFECO, already offer ETF investing in 401(k) strategies through self-directed brokerage accounts, there are commission costs associated with each trade that can add up and consequentially defeat the purpose of reducing costs.

Darwin Abrahamson, chief executive officer at Oregon-based INVESTnRETIRE said fees make a huge difference to retirement income. "The primary issue is to increase performance for participants, which can only be done by cutting costs on investment options."

Abrahamson said his firm lowers the costs associated with 401(k) plans, resulting in total expenses that are 30% to 60% lower than those affiliated with typical 401(k) service providers, by using ETFs. "With ETFs, we can cut average costs down by approximately 69 basis points, which will potentially increase a plan participant’s retirement income by retirement age," he said.