Why ETFs Are the Future of 401(k)s: Saddle River

One reason the firm has adopted ETFs so enthusiastically is that they provide exposure to areas investors might have trouble finding in a mutual fund. "There are ETFs that cover areas that mutual funds are hard pressed to cover," Wolfe said. "When you get into things like real estate and commodities, even emerging markets, there aren't a whole heck of a lot of mutual funds that cover that."

ETFs also provide more flexibility. "Most 401(k)s, when they're set up with mutual funds, they pick a handful of mutual funds" and may make some changes after a year or two. "With ETF portfolios, we can change ETFs every quarter if we want to."

For example, Wolfe said, "Last year in May, that's when the fixed income market really got hit because that's when the Fed said they were going to start raising interest rates and bonds got clobbered. At the end of June when we decided to rebalance, we moved the fixed income to bank loans and emerging market fixed income and things that were not affected by the Fed policy. We were able to make those changes —Bang! — Just like that, and settle down our fixed income allocation."

ETFs also have better expense ratios, Wolfe said. "Every time I talk to a client, they're saying to me, 'Can you help me with my 401(k)?' We can go in there with an ETF portfolio that's a lot less expensive than a mutual fund portfolio for the plan sponsor — with recordkeeping, payroll — and provide education and advisory services for less than 100 basis points. Try to do that with mutual funds."

ETFs haven't been picked up in 401(k)s much, but that's about to change. "The big problem with ETFs in a 401(k) so far is that ETFs are traded like stocks," Wolfe said. "A lot of people — the Fidelities and Schwabs and people like that — have difficulty putting ETFs in 401(k)s, but now open-architecture platforms are out there."

He continued, "The bottom line is ETFs have not being making much headway in the 401(k) marketplace; they're going to start." In fact, Schwab launched an all-ETF 401(k) in February. Prior to that, TD Ameritrade launched a turnkey program that opens up non-proprietary ETFs and mutual funds to advisors trying to get into the retirement business.

The last obstacle to adding ETFs to 401(k)s, then, might be the participant.

"It does add a layer of confusion," Wolfe acknowledged when asked how participants have responded to ETFs in their 401(k)s. "We do have to explain to participants what an ETF is. Let's face it, mutual funds are so plugged into 401(k)s now and people are so accustomed to them. We were lucky enough to have people in human resources who understood ETFs and liked the idea of lower costs."