Index funds, ETFs gain popularity as 401k options

Investors are becoming more price conscious. In response to the increased pressure to lower 401(k) costs, alternatives to traditional mutual fund investments that offer significantly lower fees are growing in popularity.

The latest offering is an all-index 401(k) plan announced Tuesday by Schwab Retirement Plan Services Inc.

The investment choices for the Schwab Index Advantage plan are limited to index funds, which are designed to track established market indexes such as the S&P 500. Index investing continues to grow in popularity because index funds do not carry the higher fees of actively managed funds. The plan will use Schwab-branded funds and those of other large well-known fund providers offering a range of equity sizes, styles, and geographies as well as bonds and other asset classes.

Schwab said it also is developing a version of the 401(k) plan that will use only index-based exchange-traded funds. ETFs also track various indexes, but they are bought and sold throughout the day like stocks. This feature has some in the retirement plan industry worried about their inclusion as an option in a 401(k) plan. The concern is some investors may be enticed to trade too frequently which could hurt their performance.

Still, the cost advantages of index investing are clear.

The average actively managed large-cap mutual fund carries an annual expense ratio of around 1.3 percent, while the average large-cap index fund costs around 0.71 percent. The expense ratio is the percentage of assets an investor pays to invest in the fund. A comparable index ETF costs around 0.33 percent, Morningstar Inc. said.

Schwab isn’t alone. Other companies are moving into lower cost index funds include The Vanguard Group, the nation’s largest mutual fund company. In September it announced plans to convert its LifeStrategy stock-and-bond funds to index-only investments from a strategy of using managed and index funds.

ING Direct has offered index ETFs in its Sharebuilder 401(k) for a few years. T.D. Ameritrade also offers an ETF option for 401(k) plans.

Fidelity Investments said it continues to believe that ETFs are not the best investment vehicles for 401(k) accounts. That’s primarily because investors should be focusing on long-term investing and the daily trading of ETFs only encourages them to try to time the market, which will likely hurt their performance, a company spokesman said.

Fidelity, which currently offers one ETF that tracks the Nasdaq exchange, has filed documents with the Securities and Exchange Commission to offer more but isn’t rushing to offer an ETF-loaded 401(k).

Fees cut into the returns of a 401(k) account and can reduce the amount saved by tens of thousands of dollars by retirement for the average worker.

“We know that through index funds we can ultimately take a lot of expense ? what we call drag ? off of the participant’s account,” said Jim McCool, head of Institutional Services at Schwab. “That translates to more money in their account just by trimming the expense factor down.”

In addition to the savings, Schwab is providing a consultation with an adviser from GuidedChoice Asset Management Inc. to help workers choose the right funds for their retirement goals.

For those who prefer to keep at least some money in cash to balance their 401(k) portfolio, the new plan also includes the option to save money in an FDIC-insured savings account with Charles Schwab Bank.

San Francisco-based Schwab services about 1,300 401(k) plans with 1.5 million participants and a total of $90 billion in plan assets.