Reducing Costs of 401(k) Plans with ETFs and Commingled Trusts

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As the role of 401(k) and similar defined-contribution plans continues to expand in our retirement system, plan participants are paying more of the cost of financing their retirement income. This study analyses the trading costs and fees of the 100 largest domestic equity mutual funds held in defined-contribution pension plans for the years 2004 through 2008. The pricing of the actively managed funds in this sample cost the average plan 0.70 of a percentage point or more in annual returns. By shifting investment options from managed mutual funds to exchange-traded funds (ETFs) or commingled trusts, 401(k) plans can align the fees they pay more closely with the expense of the services they use. This realignment can allow an average plan to reduce its administration and management fees between 0.20 and 0.40 percent of assets. In addition, the shift to ETFs and commingled trusts that hold ETFs can reduce average trading costs 0.50 percent of assets or more for participants holding managed equity mutual funds. The fees and trading costs of the domestic equity funds in this sample are not correlated with the performance of the funds. The funds with the greatest expenses tended to divide evenly between those funds that outperformed and those that underperformed the market by the largest margins.