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So what’s the big deal about ETF-based 401(k) plans?

06/04/2010:

Well, the big deal all begins with a fundamental difference in the approach to investing for the long-term. This difference has a meaningful impact on fund costs, and historically this has affected long-term performance. ETF-based 401(k) plans take an index-based approach to investing whereas traditional 401(k)s take a more actively-managed approach.

Traditional 401(k) plans are built predominantly with actively-managed mutual funds with perhaps a few lower expense index mutual funds. And there can be loads and other expenses associated with these funds to uncover. Actively-managed funds typically incur greater costs in research and trading than an index fund. For each extra dollar spent, the fund must overcome these expenses to outperform its benchmark index.

Unfortunately, the majority of these higher expense funds have not been outperforming the indexes. No one can predict future performance, but to date, history has sided with index funds. Across major asset categories, the benchmark indices have historically beaten 60-75 percent of actively-managed mutual funds over a five year period of time, according to the Standard & Poor’s Indices versus Active Funds Scorecard. It is very difficult for professional money managers to consistently achieve results similar to the targeted benchmark index – yes, the very ones ETFs are built to track.

To understand all the ways ETFs can help your 401(k) plan, please read our interview with ETF Trends.

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