Mutual Funds vs. ETFs: The 401(k) Format War

by Ary Rosenbaum
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A format war is when there is a competition between mutually incompatible proprietary formats that compete for the same market.

The most remembered format war is VHS vs. Betamax for video tape recorder dominance. As most people don’t remember, Betamax was actually the better technology. VHS won the format war because its originator, JVC licensed its technology to competitors which lowered the price for VHS video recorders (VCRs) while Sony was the only purveyor of Betamax VCRs. The other major difference was that VHS offered two hour recordings on its tape while Betamax only offered one hour recordings. Sony felt that a two hour recording made the recording inferior (which it did, remember using a VHS tape to record in SLP mode?) , but consumers wanted more tape space to record full length motion pictures (which are longer than an hour). So even though Sony had the better technology, they lost the format war because their rivals offered a product that was preferred by the masses.

The major lesson of a format war is that many times, the inferior product will win. If superior proprietary formats would always win, I would have written this article with an Apple Macintosh instead of a Windows 7 based computer. So it should be noted that the victor in a format war could be the inferior product like VHS.

When it comes to daily participant directed 401(k) plans, we have our own format war as the investment industry leader, no transaction fee mutual funds has exchange traded funds (ETFs) to worry about. While mutual funds have been the undisputed leader as the investment choice for 401(k) plans for years (ever since it replaced the annuity based model of 401(k) plans that dominated the industry earlier), certain changes in the retirement plan industry have made ETFs make a larger penetration in the 401(k) market.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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