401(k) with ETFs: Good Combination or Bad Idea?Posted on December 9th, 2010 William No comments
You may or may not be familiar with ETFs, or exchange-traded funds. ETFs are similar to stocks, and are actually traded on stock exchanges. An ETF is basically a basket that holds a collection of assets for you to invest in, such as stocks, bonds, and commodities. The price of the ETF is approximately the same as the value of its assets. Many investors find ETFs attractive because they are not actively managed and thus have lower costs than other investment products. They also tend to have fairly low capital gains, making them efficient for taxation purposes.
The question is, should you be holding ETFs in your retirement plans? At the start of 2010, about $4 billion in 401(k) assets was in the form of ETFs, so a lot of people seem to think so.
The extremely low expense ratios offered by exchange traded funds can definitely make them an attractive choice; lowering fees can dramatically impact your return on investment over the long run. They also allow you to diversify without the hassle of choosing stocks or funds yourself.
However, ETFs are often used for timing the market, which is at odds with the buy and hold strategy appropriate for retirement funds. Additionally, because 401(k) and IRA plans are already tax-advantaged, the tax benefits of an ETC don't apply.
So should you use an ETF in your 401(k)? As with many financial questions, the answer is: it depends. If you want to actively manage your portfolio - for example, investing in commodities without the hassle of taking possession, or making sure that you don't have multiple holdings that are invested in the same company - ETFs can give you the control you seek. If you tend to be a hands-off investor, however, the standard mutual funds offered by your company's plan may be just fine for you.