ETFs for 401K Portfolio Building

ETFs have become increasingly popular in taxable or self-directed IRA portfolios. A flurry of  introducing commission free ETFs will only accelerate ETF. There is another less visible but significant move to make ETFs a staple in traditional company sponsored retirement plans such as the 2.7 trillion 401(k) sector.

iShares (recently acquired by BlackRock) established iShares401k.com to promote ETFs within the 401(k) industry. Two vendors AdvisorETF401k and Ascensus have signed up to provide iShares ETFs for 401(k) plans.

It is interesting to note that Ascensus provides an aggregate ETF trading platform for participants. Based on a document on the Ascensue web site, "All trades submitted for the day for each ETF on the Ascensus platform will receive the same average share price. The average share price is calculated based on the market price received for actual shares traded plus the fees noted below. This method allows for automation of trades, which minimizes trading costs, and enables participants to own whole and fractional shares of ETFs." That certainly makes ETF trading more like traditional mutual fund end of day settlement.

Sungard provides an ETF 401(k) platform also allows late day processing for ETFs: i.e. ETFs trades are treated as mutual funds and they are settled using market close prices at 4pm EST. This restriction/feature is arguable but certainly makes ETFs more like long term portfolio building elements instead of intra-day trading vehicles. The other salient feature for Sungard's solution is that it allows participants to hole fractional ETF shares, much like mutual funds. This is very important for small accounts, which are typical in retirement 401(k) accounts.

Interested readers are referred to MyPlanIQ's iShares ETFs plan to see how these ETFs could be used in constructing a portfolio. There are a total of 187 iShares ETFs that cover major asset classes including US Equity (various Russell 1000, 2000, 3000 ETFs including IWF, IWB, IWD, IWZ, IWV, IWW, IWP, IWS, IWO, IWM, IWN, IWC, IWR and S&P large/mid and small cap ETFs), Foreign Equity (EFA, SCZ, ACWX), Emerging Market Equity (EEM), Real Estate (IYR and various foreign REITs such as IFGL) and US Fixed Income (AGG and many well known bond funds such as TLT, IEF, SHY, TIP, MBS, MUB, LQD, CFT, CSJ, HYG) and foreign bonds (EMB, IGOV). As in Vanguard's ETFs, the only major asset class missing is commodities. That, however, is a major asset class not covered by traditional mutual funds in most 401(k) plans anyway.

Another noticeable ETF 401(k) provider is ShareBuilder401K whose goal is low cost. It is sponsored jointly by ING Direct and ShareBuilder, a discount brokerage. Costco recently launched a Costco ShareBuilder 401k plan that has become popular among small businesses. The ShareBuilder401K consists of 15 ETFs. One noticeable major asset missing is Real Estate Investment Trusts (REITs). It would also be improved with more coverage on asset classes such as fixed income and foreign bonds. MyPlanIQ has constructed a plan to help participants in ShareBuilder401K in portfolio building. Both iShares ETFs plan and ShareBuilder 401K Plan have shown that it is possible to achieve very reasonable performance if proper portfolio strategies such as the Strategic Asset Allocation and Tactical Asset Allocation strategies provided by MyPlanIQ are used.

In an effective retirement plan using mutual funds or separately managed accounts, the key factors to select candidate funds in a plan are low cost, quality of funds and quality of diversification. With ETFs, low cost is a standout factor but it still varies from one ETF to another. The uality of funds include how close those ETFs track their intended benchmarks (so called tracking errors), liquidity and bid-ask spread (trading friction). The quality of diversification or coverage is about how many major and minor asset classes are covered by the candidate funds, as discussed above. A follow up article will give more detail on how to construct and rate a good ETF plan.

Tom Lydon has written several good articles on ETFs in 401(k) such as this and this. In addition, IndexUniverse.com has done excellent coverage on this topic such as this article.

Commission-free ETFs Enable Portfolio Building Using Asset Allocation Strategies

The latest Vanguard announcement on offering all the company's 46 ETF trades commission free marks a new era for ETFs. In our opinion, with trading costs removed, ETFs are now a viable alternative to index and actively managed mutual funds in portfolio building and asset allocation.
Three brokerage firms, Vanguard, Fidelity and Schwab, have announced commission-free ETFs. Let's first compare them in the following table:

Asset Classes	Sub Asset Classes	Vanguard	Fidelity	Schwab
US Equity	Large Cap	MGC, MGK, MGV, VTI,VTV, VUG, VXF,VV,VIG, VYM	IWD, IVV, IWB, IWV, IVW, IWF,IVE	SCHB, SCHX, SCHG, SCHV
US Equity	Mid Cap	VO, VOT, VOE	IJJ, IJH, IJK
US Equity	Small Cap	VB, VBK, VBR	IJS, IWN, IJR, IWM, IJT, IWO	SCHA
Foreign Equity		VT, VEU, VSS,VEA,VGK,VPL	EFA, ACWI, SCZ	SCHF, SCHC
Emerging Mkt Equity		VWO	EEM	SCHE
REIT		VNQ
US Fixed Income	Treasury Government	VGSH, VGIT, VGLT, EDV, VMBS	TIP, MUB
US Fixed Income	Corporate	VCSH, VCIT, VCLT	LQD
US Fixed Income	General	BSV, BIV, BLV, BND	AGG
Intl Fixed Income		N/A	EMB
Sectors		VPU, VOX, VAW, VGT, VIS, VHT, VFH, VDE, VDC, VCR

From the table, one could see that Vanguard commission free ETFs covers most of major and minor asset classes. Schwab, on the other hand, offers limited coverage. Schwab's ETFs have relatively short history but,  given Schwab's reputable mutual funds, one would expect these ETFs would offer competitive performance compared with iShares and Vanguard's ETFs.  Among all of the offerings, asset class foreign bonds and commodities are noticeably missing. From diversification point of view, we would like to see those asset classes are covered. 
The significance of commission free ETFs should not be understated: periodically rebalancing of a portfolio using strategic asset allocation is now free and at will, no more redemption and round trip charge (though we are not advocating frequent trading), no more lockup period and various fund classes (remember those class A, B, C, D, Y, Z  shares?).
Commission free ETFs make very good instruments for constructing a portfolio using a good tactical asset allocation strategy. Remember academic research keeps reminding people of the trading cost? It is gone. Now, one could build an ETF based portfolio using some of best tactical asset allocation strategies. For example, on MyPlanIQ.com, it offers a Vanguard ETFs plan that has several model portfolios based on Strategic Asset Allocation (SAA) and Tactical Asset Allocation (TAA). The following table shows the comparable performance among VBINX (Vanguard Balance Fund Index, a 60% stock and 40% bond portfolio), SAA moderate portfolio and TAA moderate portfolio.
The following illustrates the performance comparison among TAA, SAA and VBINX.



The performance comparison is as follows:

	1 yr AR	1 yr Sharpe	3 Yr AR	3 YR Sharpe	5 YR AR	5 YR Sharpe
Vanguard ETF TAA (P_16707)	27%	1.8	11.6%	0.74	15.6%	1.01
Vanguard ETF SAA (P_15214)	30%	2.06	5%	0.2	10%	0.46
Vanguard Balance Fund Index (VBINX)	18.1%	1.7	-1.75%	-0.15	3.4%	0.11

Commission free ETFs are not free of problems. The major remaining issue is the trade friction or so called bid and ask spread: with an index mutual fund, one has no such a problem. This problem is exacerbated by low volumes for some ETFs. Care should be still given for those ETFs. We expect, however, the growing volume and popularity of ETFs will eventually make these problems less serious. 

We applaud the recent industry moves and are looking forward to more such moves to make them completely free.  We believe this represents a significant step forward to further level play fields between retail investors and professional investors.

Introducing a New Service: MyPlanIQ for ETFs, Mutual Funds, 401(k), Variable Annuities, VULs Investments

Dear ValidFi Users,

As a registered and active ValidFi user, you have given us valuable suggestions and questions in the past. We appreciate your interests and help. We are pleased to announce the first relase of MyPlanIQ -- http://www.myplaniq.com/. Your ValiDfi username and login has been transferred to MyPlanIQ and you are welcome to log in at any time.

We learned from ValidFi users that there is a need for easy to use portfolio creation tailored to a wide range of investments: self directed brokerage accounts using ETFs or mutual funds, 401(k), 529, Variable Annuity portfolios, Variable Universal Life (VUL) portfolios.

MyPlanIQ solves the problem by building a portfolio driven by advanced strategy, your risk profile, and mapped only to what your plan makes available.

At the moment, MyPlanIQ supports two major strategies: Strategic and Tactical Asset Allocation. The Tactical Asset Allocation strategy is a variation of ValidFi's Goldman Sachs Global Tactical Asset Allocation strategy that has been popular among ValidFi's users. If you are looking for a corresponding plan in MyPlanIQ.com for such a portfolio, we suggest you look at plan Diversified Major Asset ETFs Goldman Sachs Global Tactical Asset Allocation.

As time goes, we plan to support more strategies including Guru Asset Allocation Clones.

As in ValidFi, MyPlanIQ monitors the portfolios daily and will send you rebalancing email alert if there is a rebalancing event monthly.

MyPlanIQ is subscription based. The plan costs $9.95 a month (or $99.5 a year). We believe low cost is one of the key advantages for us to deliver values.

The default setting is free while working with data that is delayed one quarter. As an active Validfi user, you can register for active data and will receive an extended six month trial period.

Thank you for your continuous interests and support.

ValidFi staff