Mutual funds and company stock are the traditional offerings in most employer-sponsored retirement plans. Some plans also offer the option to invest in exchange-traded funds, also known as ETFs. Investors who have a self-directed brokerage option through their 401(k) also could have the ability to select ETFs.
What is an ETF?
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- An ETF is an investment shell (mutual funds also are investment shells) that trades throughout the day on an exchange rather than valuing once daily at close-of-business like a mutual fund.
- ETFs are less regulated than mutual funds, so they have the ability to carry underlying investments that are more diverse, like commodities, precious metals or currencies.
- Capital gains or losses only result when an investor sells an ETF, whereas mutual fund investments incur capital gains or losses when an investor sells mutual fund shares and when fund managers sell investments within the fund. This ETF tax benefit does not extend to 401(k) plans and other employer-sponsored plans since they are tax-deferred and never subject to capital gains taxes.
- Many ETFs track an index, like the S&P 500 or MSCI EAFE – making them similar to index funds.
- Typically, ETFs have a brokerage fee/commission for buying or selling, just like trading stocks.
- Since ETFs can be traded throughout the day, short-term speculation or day-trading can result.
- The price of an ETF is determined by supply and demand – whereas mutual fund share prices are determined by the value of the securities the mutual fund holds. Low demand for an ETF can drive the price above or below the value of the underlying holdings.
- Index ETFs often are managed more passively than index funds.
Head over to Financial Engines’s website for more information on ETFs.