ETFs Slowly Displace Mutual Funds in 401(k)s

BOSTON ( TheStreet) -- BlackRock ( BLK), the largest seller of exchange traded funds, is helping to push more Americans toward ETFs instead of mutual funds in their 401(k) plans.

Americans held $3.9 trillion in employer-based defined-contribution retirement plans, of which $2.7 trillion was held in 401(k) plans as of Sept. 30, according to the Profit Sharing/401k Council of America. Mutual funds had $2 trillion of those assets, but ETFs are starting to chip away, as they have with everyday trading among institutional and individual investors.

BlackRock estimates that as much as $2 billion of its iShares funds are now held in 401(k) plans, accounting for half that market. "Within the 401(k) space in the next five years, it is conceivable that flows to ETFs could reach several billion dollars," says Darek Wojnar, head of product research and strategy at BlackRock's iShares, its ETF unit.

ETFs may not seem a good fit. Because you don't need to pay taxes on capital gains in retirement accounts, ETFs' inherent tax advantages are mitigated. Active investors may love the intra-day trading ability of the funds, but within 401(k) plans, that feature isn't desirable -- or even feasible.

The main selling points are low and transparent fees. According to BlackRock, the average expense ratio of an iShares ETF is 0.41% versus the average mutual fund's 1.50%, a difference that can result in tens of thousands of dollars over 30 to 40 years.

BlackRock isn't treading on new turf. ShareBuilder 401(k), a subsidiary of ING Direct ( ING) that sells 401(k) plans to small businesses, has provided ETF-based vehicles for four years. Vanguard Group, the third-largest provider of ETFs, uses index mutual funds for its own 401(k) offerings, but has marketed ETFs to other plans for several years.

In 2007, WisdomTree Investments ( WSDT) created a business unit designed to deliver ETFs to the 401(k) marketplace. In all, the company sells 52 funds.

Small businesses have been early adopters of ETFs in their retirement plans because of lower costs. That trend may continue until larger companies join the fray. When that happens, mutual funds' dominance may slip quickly.

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