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For decades, many investors have been stuck using second-rate investments to try to save toward their retirement. With a new trend that's starting to take hold, however, retirement investing is pushing in a different direction, and the result could make you much happier about your retirement saving options.
Dealing with disaster
Two years ago, during the depths of the financial crisis, people were just about ready to write off employer-sponsored retirement plans like 401(k)s. Not only were workers suffering from the drop in the broad stock market, but many retirement plans featured mutual funds that were subpar investment choices, causing participants to lose even more than the market did. Add to that the ridiculously high fees that many plans charged, and it was easy to understand the frustration that everyone felt as they watched a decade's worth of profits go up in smoke.
In the brand-new edition of Rule Your Retirement's Champion Funds quarterly feature, Fool fund expert Amanda Kish addresses retirement investing in more detail. In particular, she has identified a new kid on the employer-sponsored retirement plan block, and it's giving mutual funds a run for their money. And if you're participating in your own employer's plan, you could soon start seeing new low-cost, easy-access investments popping up in your 401(k).
ETFs make their move
The hot new investment in the retirement space is the exchange-traded fund. ETFs have been on the upswing for years among regular brokerage accounts, giving you the ability to trade funds like a stock rather than having to wait until end-of-day pricing kicks in.
The downside, though, is that to buy them, you have to pay whatever commission your broker charges. For a long time, that made ETFs a bad choice for 401(k) plans, because you'd theoretically have to pay a commission every time you made a new contribution from your paycheck, as much as 50 times each year.
Recently, though, brokerage companies like Fidelity, Charles Schwab (NYSE: SCHW ) , and Vanguard opened the door to commission-free ETF investing, and it appears that the trend toward lower commissions will continue. According to Kish, Blackrock (NYSE: BLK ) has started working with 401(k) plan providers to offer low-cost all-ETF retirement plans aimed at small businesses.
Other ETF providers haven't been attacking the 401(k) market as hard. Invesco (NYSE: IVZ ) , which runs PowerShares, offers small business retirement plans, but hasn't linked PowerShares ETFs directly to those plan offerings. State Street (NYSE: STT ) , which manages SPDR ETFs, includes defined contribution plans like 401(k)s among the investment services its Global Advisors unit offers, and given that its brand new global head of its defined contribution segment came from Blackrock, you can expect sparks to start flying in the 401(k) ETF space.
What it means for you
From your perspective as a plan participant, the greater availability of ETFs within 401(k) plans could be a big improvement over high-fee mutual funds. In her article, Kish points out that because most big ETFs are designed as passive index investments, going with the lowest-cost provider usually makes sense.
Regardless of which ETF provider your employer goes with, you can typically find suitable choices. For large caps, the pioneering SPDR Trust (NYSE: SPY ) is still a good choice for exposure to the S&P 500 index. The iShares Russell 2000 ETF (NYSE: IWM ) does a similar job for small-caps, while Vanguard Emerging Market Stock ETF (NYSE: VWO ) provides a one-stop shop for emerging market stocks. In general, sticking with these broad categories with their extremely low annual costs is the most efficient way to build a strong low-cost retirement portfolio.
Some may argue that since ETFs are used so often by traders, they're unsuitable for long-term goals like retirement. But used correctly, they can do a lot better than many active mutual funds. Such a move could be exactly what 401(k) plans need to restore the confidence that was shattered during the last bear market.
To read all of Foolish fund expert Amanda Kish's article, as well as the rest of her Champion Funds update, all you need is a trial subscription to Rule Your Retirement. The good news is it's absolutely free for 30 days, so try it out today!
Tune in every Monday and Wednesday for Dan's columns on retirement, investing, and personal finance.