The Next Wrinkle in Your 401(k)

ETF funds will soon be commonplace in company retirement plans.

Retirement Guide 2008
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Exchange-traded funds, often lauded for their low fees and easy diversification, are angling for your retirement money. But this budding class of investments can't seem to gain a foothold in the mutual fund-dominated 401(k) business. "Traditional fund companies have a stranglehold on those plans," says Jeffrey Ptak, head of ETF research at Morningstar.

There are other hurdles, too. Unlike mutual funds, which are priced once at the end of each day, ETFs trade like stocks. That makes record keeping a challenge for traditional 401(k) platforms. Another issue is that ETFs don't jibe with dollar-cost averaging, a strategy 401(k) investors use when making regular contributions. As is the case with stocks (but not mutual funds), ETF investors must pay commissions on each trade, which can wipe out ETFs' low-expense benefits.

Some sponsors are sidestepping these issues by offering mutual funds that invest in ETFs rather than individual stocks or bonds. Others, including Barclays Global Investors and WisdomTree, are devising their own systems to support ETF trading within 401(k) plans. Providers are also finding ways to reduce commissions, such as pooling buy and sell orders from a large number of investors into a single order.

Targeting. Another way EFTs could make headway in the retirement market is by modeling offerings after one of the mutual fund industry's fastest-growing products: target-date funds. One of the few pure-ETF options is the TDAX Independence Target-Date funds, which provide exposure to hundreds of stocks and bonds and shift allocations to become more conservative over time. The ETFs, which range in target dates from 2010 to 2040, are able to minimize transaction fees because buy and sell orders are pooled, says Anthony Dudzinski, chief executive officer of the funds' sponsor, xshares Advisors.

Recent calls from government agencies for greater fee disclosure in 401(k)'s may also help ETFs push into the retirement market, since transparency is a big selling point for the funds. "ETFs will be one of the items on the [401(k)] menu," Ptak says. "They're getting too profitable and too prominent to go on ignored."