If you are considering adding ETFs to your 401(k) plan, you should be familiar with what your recordkeeper charges for using those assets in your plan. Note: It is extremely likely that your recordkeeper will charge an additional fee for ETFs, over the use of mutual funds. Recordkeepers typically price ETFs in one of two ways:
- Asset-based fee – Your recordkeeper could add an additional basis point charge to all assets in a plan that includes ETFs in its investment lineup. Thus, you would be paying slightly more in recordkeeping costs for a plan that included ETFs, rather than just mutual funds. Under this arrangement, all participants would incur higher fees, regardless of whether they are invested in ETFs or only mutual funds.
- Transaction commissions per share – Your recordkeeper may charge a per share transaction fee for each ETF purchase and sale; this fee is generally debited from the proceeds of the transaction. Only participants who invest in ETFs pay the transaction commission fee. Some recordkeepers may charge a different fee based on when ETF trades are submitted. For example, if the recordkeeper submits the plan's trades prior to market close, it may charge a discounted per share fee for each ETF transaction. However, this fee may only be applicable for purchases or sales only; i.e., if the ETF was part of an exchange with another fund, the higher fee may apply. For recordkeepers that offer same day exchanges between fund families (nearly a standard practice in the 401(k) industry), mutual fund trades cannot be submitted prior to market close. Thus, a plan with both mutual funds and ETFs would likely subject its ETFs trades to the higher per share fee. The reason: the recordkeeper will most likely submit the ETF trades at the same time as mutual funds, allowing plan participants to exchange between ETFs and mutual funds.
ETFs might be a great addition to your 401(k) plan. However, when considering the overall cost to the participant, it is important to factor in an additional fee that a plan may be charged for using ETFs as opposed to simply mutual funds. Whereas an asset-based surcharge is a very simple and transparent way for plans to determine the additional cost of using ETFs, transaction based fees are a little murkier because they depend not only on the per-share cost of the trades, but also to the trading frequency of a plan's participants. "Buy and hold" investors will experience lower transaction costs than the frequent traders.
* How ETFs Have Reshaped Investing. The Wall Street Journal, April 18, 2011.