Exchange-traded funds (ETFs) are increasingly being viewed as the "last frontier" for 401(k) plans.

• While exchange-traded funds are widely used by investors, they have not seen significant adoption in workplace retirement plans.
• ETFs have some benefits that are not applicable in a 401(k) context, according to experts.
• Some obstacles were mentioned, including technology infrastructure and third-party costs, they stated.

Despite the popularity of exchange-traded funds among investors, they have not seen significant growth among 401(k) plan participants.

Since their introduction in the early 1990s, exchange-traded funds (ETFs) have amassed approximately $10 trillion in assets under management.

ETFs have gained market share from mutual funds, with their holdings accounting for 32% of the total assets, up from 14% a decade ago, according to Morningstar Direct data.

David Blanchett, head of retirement research at PGIM, stated that ETFs are gaining popularity as a new structure for wealth management accounts.

Despite the enthusiasm of ETFs, investors in workplace retirement plans have not shown the same level of interest, representing a significant untapped market for the ETF industry.

In 2023, 401(k) plans held a total of $10.4 trillion, with over 70 million participants, according to the ICI. Additionally, other 401(k)-type plans, such as those for university and local government workers, held an additional $3 trillion, as per ICI data.

But hardly any of those assets are in ETFs, experts said.

Philip Chao, a certified financial planner, stated that there is a significant amount of money in workplace plans and this trend is expected to continue.

Experiential Wealth founder Chao stated that ETFs are reaching their final frontier as they attempt to capture the next significant pool of funds.

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At the end of 2023, 65% of 401(k) assets were invested in mutual funds, while ICI data does not provide a corresponding statistic for ETFs.

The Plan Sponsor Council of America, a trade group representing employers, reports that ETFs hold only a small portion of the remaining 401(k) assets.

In 2022, the PSCA report analyzed the popularity of various investment structures, including mutual funds and ETFs, across 20 different types of investment classes. The report discovered that 401(k) plans utilized ETFs for sector and commodity funds only 3% of the time.

Key benefits are 'irrelevant'

According to PSCA data, the majority of 401(k) assets were invested in mutual funds, collective investment trust funds, and separately managed accounts across all categories.

Investment vehicles serve the same fundamental purpose: They collect funds from investors.

However, there are some differences.

Experts said that ETFs offer investors advantages such as tax benefits and intraday trading.

Blanchett stated that the benefits of 401(k) plans are "irrelevant."

He stated that since the tax code already provides preferential tax treatment to 401(k) accounts, the advantage of using an ETF over capital gains tax is insignificant.

In 2023, only 11% of 401(k) investors made a trade or exchange in their account, according to Vanguard data. Blanchett stated that 401(k) plans are typically long-term accounts where frequent trading is generally discouraged.

In retirement plans, employers act as a decision-making layer between funds and investors in the workplace.

ETFs may not be available to 401(k) participants as company officials decide which investment funds to offer.

There may also be technological roadblocks to change, experts said.

The infrastructure of traditional workplace retirement plans is not equipped to handle intraday trading, which means it is not designed for ETFs. According to Mariah Marquardt, capital markets strategy and operations manager at Betterment for Work, in a 2023 analysis, orders for mutual funds are only priced once a day, at the end of the market day.

Experts noted that ETFs have payment and distribution arrangements that mutual funds cannot accommodate.

The total mutual fund fee an investor pays in a 401(k) plan can vary depending on the share class, and may include fees for multiple players in the ecosystem, such as the investment manager, plan administrator, financial advisor, and other third parties.

The net mutual fund fee is divided and distributed among various parties, but investors typically do not see those expenses on their account statements, according to Chao.

ETFs have only one share class, which means they cannot bundle together distribution fees. As a result, investors' expenses are shown as multiple line items, according to Chao.

"Many individuals prefer having only one item," Chao stated. "It gives the impression of not incurring additional costs."

"It's almost like ignorance is bliss," he said.