Apple (NASDAQ:AAPL), as it turns out, is not just an innovator in the technology sector (NYSE:XLK), but it’s also an innovator in how it manages its company-sponsored 401(k) retirement plan.
The iPhone and iPad developer has the bulk of its 401(k) assets in ETFs, according to a Bloomberg report titled “ETF growth seen as 401(k) sponsors include ETFs.”
Although the 401(k) market still is dominated by traditional mutual funds, ETFs are changing the dynamics of the retirement plans market.
Eliminating Previous Barriers
The resistance to use ETFs inside retirement plans is rapidly disappearing because forward-thinking companies like Apple are embracing them. Many employees with a 401(k) plan already own ETFs in their other investment accounts, so there’s a high comfort level with owning ETFs inside their retirement plan.
Also, the ETF industry is gearing up for its next phase of growth, which will come from 401(k) plans along with other retirement plans like 403(b) and 457 plans. Currently, less than 1% of $1.2 trillion invested in exchange-traded products is from 401(k) plans.
401(k) Market Turned Upside Down
The ETF(k) movement is spurring innovation in the 401(k) market, as providers like Invest n Retire move to meet investor demand. The Portland, Oregon-based company offers asset allocation models with ETFs and the ability for companies to transfer their fiduciary responsibilities to ETF managers. Invest n Retire has a patent on its all-ETF retirement platform, and it generally caters to 401(k) plans with more than $5 million in assets.
Other ETF(k) providers offer retirement plan solutions through a self-directed brokerage window or collective investment trusts. While there’s internal debate within the ETF industry about which of these solutions is best for 401(k) investors, it hasn’t diminished the adoption rate of ETFs inside 401(k) plans.
Why are companies like Apple turning to ETF(k) plans? Here are just a few reasons why:
The annual expense ratios for ETFs* are consistently lower compared to mutual funds in the same investment category. The money saved by 401(k) participants from lower investment fees can translate into a substantial increase in retirement income. New ERISA fee disclosures are forcing companies to adopt lower cost investments.
Since the onset of the 2008-09 financial crisis, more demand for financial transparency has been created. And ETFs disclose their portfolio holdings on a daily basis, making it easy to quickly identify underlying holdings. On the other hand, mutual funds only disclose their holdings quarterly or semi-annually.
ETFs offer more complete coverage of the asset class universe compared to mutual funds. An ETF(k) plan, for example, can include important investment categories like commodities (NYSE:GSG), gold (NYSE:IAU), global real estate (NYSE:RWO), global TIPS (NYSE:GTIP), international government bonds (NYSE:BWX) and international small-cap stocks (NYSE:VSS). Unfortunately, most of these areas are not included in the typical mutual fund 401(k) plan, which makes the plan deficient in the area of diversification.
Better Investment Returns
The bulk of ETFs are linked to market indices, which have historically outperformed Wall Street’s money managers. “Indices have outperformed a majority of active managers in nearly all major domestic and international equity categories,” reported Standard & Poor’s in its mid-2011 survey of “S&P Indices Versus Active Funds Scorecard.”
“In addition, five-year asset-weighted averages suggest that active managers have fallen behind benchmarks in 11 out of 18 domestic fund categories.”
ETFs are changing the dynamics of the 401(k) market for the better. Compared to mutual funds, they offer lower costs, 100% transparency, greater diversification and better long-term investment returns.
Eventually, I believe this will reach a tipping point, where 401(k) sponsors are forced to explain why they aren’t offering ETFs inside their 401(k) plan.
Ron DeLegge is the Editor of ETFguide.com and author of Gents with no Cents: A Closer Look at Wall Street, its Customers, Financial Regulators and the Media. (Half Full Publishing, 2011.)
* Footnote: According to ETFguide’s Q1 2012 data, here are the expense ratio medians for key ETP categories:
Large Cap Stocks: 0.2%
Mid Cap Stocks: 0.25%
Small Cap Stocks: 0.25%
Global & Intl Stocks: 0.53%
Emerging Mkt Stocks: 0.62%
U.S. Industry Sectors: 0.48%