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ETFs and Retirement Planning

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Experts Weigh in on ETF Strategies for 401k Plans

How ETF Strategies Benefit Retirement Saving Plans

Hafeez Esmail from Main Management explains how ETF managed solutions can help one’s retirement savings strategies. “Most retirement savings plans offer plan participants a variety of mutual fund choices. These participants currently pick their own mutual fund allocations, which many leave unchanged for years.

The vast majority of participants that pick their own portfolios have little or no financial expertise. However, they are making the asset allocation decisions that affect 90% of the variability in their portfolio returns themselves.”

ETF Strategies Outperform Traditional Mutual Funds

The numbers bear it out. According to Main Management’s research traditional plan participants underperform broad based ETF strategies using indexes often by hundreds of basis points per year. Compounded over decades the difference can be tens if not hundreds of thousands of dollars in lost retirement savings.

Plans offering ETFs provide some respite. ETFs generally are low cost, static portfolios of stocks that mirror benchmark indexes such as the S&P 500. By contrast, mutual funds hire a manager to pick individual stocks and typically charge a higher expense ratio for this service.

“Ironically only about 30% of large cap managers that benchmark themselves to the S&P 500 actually beat this index on a five year basis,” explains Esmail. “When buying a mutual fund, one typically pays more for lesser performance than purchasing a broad market ETF with a lower expense ratio and usually less risk. As a result, plans rich in ETFs tend to offer a better set of outcomes for participants than do mutual fund plans because of the lower fees and broad diversification offered by ETFs.”

Plans with significant ETF offerings are only part of the solution. Main Management advises that offering an ETF managed solution is critical. It eliminates the difficult burden of a plan participant making important asset allocation decisions over the life of the retirement plan. Outsourcing the asset allocation decisions to an institutional ETF money manager plan participants greatly improve their chances of superior performance. In addition, participants may get a better outcome without taking on substantial risks.

Disadvantages of ETFs

The only disadvantage to ETFs is that not all ETFs are created equal. “Just like mutual funds which have bad funds, ETFs also have bad funds like Exchange traded Notes,” clarifies Abrahmson.

Abrahamson and Esmail agree that understanding the structure of an ETF is important to appreciate how it might actually operate versus its stated goal. “This underscores the need for an ETF money manager with extensive understanding of the different ETF options,” explains Esmail. “As with mutual funds, ETF decisions in the hand of inexperienced investors might also be a recipe for disaster.”

Given this information, retirement plan administrators would benefit from taking a closer look at ETF managed solutions given that they appear to offer far better prospects for plan participants than the status quo.