Should You Invest In ETFs With Your 401(k)?
Written by
Gina Hagler
Edited by
Cory Dudak
Commitment to Our Readers
GOBankingRates' editorial team is committed to bringing you unbiased reviews and information. We use data-driven methodologies to evaluate financial products and services - our reviews and ratings are not influenced by advertisers. You can read more about our editorial guidelines and our products and services review methodology.
20 Years
Helping You Live Richer
Reviewed
by Experts
Trusted by
Millions of Readers
Exchange-traded funds, or ETFs, are a type of pooled investment security that act like individual stocks in how they are bought and sold. They differ from mutual funds, which trade once a day after close, and can be used to track anything from commodities to securities. ETFs are increasingly popular for investors and traders because of their affordability through low expense ratios and fewer broker commissions. Given this trend, you might wonder if you should invest in ETFs with your 401(k).
Here are some considerations when deciding if they would be a good choice for you.
- They can reduce your overhead costs but it depends on the type of ETF. Passively-managed ETFs are often less expensive because they target a broad index — investors only have to make one transaction to buy and one to sell, rather than buying everything individually. On the other hand, actively managed ETFs, which don’t target an index of securities, conversely don’t carry this opportunity for lower average costs.
- If your 401(k) plan lacks commission-free trading, the broker buy and sell fees can add up. You’ll benefit from the brokers that offer no-commision trading on lower-cost ETFs.
- You can diversify your 401(k)s asset allocation by investing in an ETF that tracks large indexes, but single-industry-focused ETFs conversely limit your portfolio diversification. Therefore, you’ll want to avoid ETFs focusing on targeted industries.
- You might not save as much in the long term if your goal is to avoid the short-term capital gains tax. This is due to earnings being taxed as ordinary income.
- ETFs lack liquidity, which negatively affects transactions.
- ETFs have lower turnover – they only occur when a company is removed from an index.
In deciding whether or not to add an ETF to your 401(k), make sure you fully review how your portfolio could be affected in the future. 401(k)-matching from your employer could prove to be more beneficial for your savings — you always want to be aware of how much you need to retire comfortably. A good idea if your portfolio has mostly high-cost investments is to trade some of them for ETFs and improve your savings growth.
More From GOBankingRates
- 7 Bills You Never Have To Pay When You Retire
- 6 Hybrid Vehicles To Stay Away From Buying
- Here's How to Add $200 to Your Wallet -- Just For Banking Like You Normally Would
- I Retired in My 70s: Here's My Monthly Budget
