Tell me about ETFs', are they a good investment, is anyone else vested in one?

Answer 1

You can save tens of thousands of dollars over the long run by investing in exchange-traded funds rather than mutual funds. Those higher fees add up.


In planning for your retirement, you can invest in exactly the same thing in either of two ways. One will put tens of thousands of dollars more into your pocket.

This isn't a trick. Exchange-traded funds, or ETFs, are cheaper to operate than mutual funds, meaning fewer of your profits are gobbled up by middlemen.

ETFs are index funds stripped of the back-office expenses of mutual funds and traded like stocks throughout the day. You can plunge into financial markets at the opening bell and exit at the close, which you can’t do (legally) with funds, or you can buy them and hold them to accumulate their higher returns (because of their lower cost) for a lifetime.

With these portfolios you’re buying pure market risk and nothing else. In investing, everything else is a lot. A mutual fund manager could lose his way, zagging down even though his marketplace is zigging ahead. Or his back office could be illegally dealing with hedge funds, which cost mutual fund investors more than $2 billion in the scandals uncovered one year ago. Start investing with $100.


“ETFs are like a designated driver -- you don’t have to worry about them,” says Tom Taggart, a managing director of Barclays Global Investors, a prime sponsor of exchange-traded funds.

More properly, you have to worry only about the market, but ETFs have other attributes that can help you play it like a pro. You can buy them on margin, borrowing cash from your broker to leverage up exposure to markets you like. And you can sell them short, a negative bet in which you borrow shares and sell them, expecting to buy them back later at a lower price.

Not for everyone
Because they trade like stocks, meaning you pay brokerage commissions to buy them, ETFs are economical in bulk, as in established accounts and IRA rollovers. They’re not useful when you’re buying in small quantities, such as monthly contributions to a 401(k). Low-cost mutual funds are clear winners for that strategy, as they are for active portfolio management. But for indexing, ETFs are nearly impossible to beat.

I run a model investment portfolio and it uses ETFs exclusively because they're the most efficient portfolios for my purposes. And I’m hardly alone. Investors are flocking to ETFs. As of Aug. 30, there were 143 ETFs with combined assets of $174.51 billion, up $57.23 billion, or 49%, from one year earlier, the Investment Company Institute says. In the same period, assets of mutual funds advanced 7.1%.

You can buy ETFs representing almost every equity index, from the Standard & Poor's 500, the most popular, to Morgan Stanley Capital International's indexes for regions like Europe and the Far East. The largest domestic bond categories are also represented, like the Lehman Aggregate Bond Index.

Most popular ETFs
Security Assets in $ billions
S&P Spiders (SPY, news, msgs) 46.19
Nasdaq-100 Tracking Stock (QQQ, news, msgs) 23.03
iShares Trust S&P Index (IVV, news, msgs) 8.49
Diamonds (DIA, news, msgs) 7.55
S&P Midcap 400 Spider (MDY, news, msgs) 6.88



As I noted in a column in August, indexing is the safest approach to long-term investing because it’s impossible to predict which top-performing fund now will continue to excel for decades to come. Even if you could, the costs active managers spend on research, and their companies spend on marketing, come directly out of your pocket.

“The case for active management is not strong, so the case for indexing is by definition stronger,” says Tom Coyne, editor of the Index Investor newsletter. Plus, it’s cheaper. Indeed, an annual subscription to Coyne’s newsletter is $25, a fourth to an eighth what typical investment newsletters charge.

A big difference
How cheap? The average total stock market index mutual fund charges annual expenses of 0.51%, or $51 on a $10,000 investment, according to Morningstar. Vanguard Total Stock Market Vipers (VTI, news, msgs), which offers this same exposure to the entire domestic equity marketplace, charges 0.15%, or $15. The average actively managed domestic equity mutual fund charges about 1.5%, or $150 in annual fees.

So if you invested $5,000 a year over 30 years in the Vipers and received the market’s historical return of 10.34%, you'd have a balance of $861,128 after fees were deducted. After fees in the average index mutual fund, you’d end up with $802,299, some $58,829 less. The other guy drives into retirement wearing a cheap gold watch. You drive a free Mercedes.

These calculations assume $5,000 lump-sum contributions annually, and a $10 commission on each ETF purchase. If I were buying, say, $500 worth, that would amount to 2%, a percentage so high it would take away the ETF’s advantage. So in my children’s Roth IRAs, I invest in the mutual-fund equivalent of the Viper, Vanguard Total Stock Market Index (VTSMX) fund. Its annual expense ratio is 0.20%.

ETFs are cheap because of their design. A mutual fund has to hold cash in reserve to meet possible redemptions, and it has to hire a staff to answer the phone and mail statements. ETFs are fixed portfolios, always 100% invested, and they're completely fungible: They can be exchanged (at the institutional level) for the underlying securities upon demand.

ETFs share many attributes with closed-end funds, which are also fixed portfolios that trade like stocks. But closed-ends aren't fungible, and therefore their market prices are often very different than their net asset value (NAV). At the most extreme, Gabelli Utility Trust (GUT, news, msgs) was trading at a premium of 47% to its NAV on Oct. 13. Another closed-end, Equus II (EQS, news, msgs), was trading at a discount of 26%.

On the same day, the S&P 500 Spiders were trading at a discount to NAV of 0.19%. Were it any higher, arbitrageurs could simply swoop down and buy enough shares to exchange them for the stocks.

Building a core portfolio
By the same token, illiquid markets don’t lend themselves to ETFs. There are no exchange-traded funds that invest in domestic junk bonds or foreign bonds of either high (developed markets) or low (emerging markets) quality.

“Operational issues such as pricing of bonds, liquidity and appropriate indexes to track increase the complexity” of these markets, Taggart says, although he adds that Barclays plans to introduce more fixed-income ETFs.

Therefore, a well-rounded portfolio can’t (yet) be built entirely with ETFs. But a core portfolio certainly can. My model includes small-cap stocks as well as large, and foreign as well as domestic, plus bond funds with varying degrees of interest-rate risk.

Even if you don’t invest in ETFs, you can be grateful they exist. Fidelity Investments recently lowered the expense ratios of certain of its index funds, mostly to compete against Vanguard Group’s mutual funds, but also to compete against ETFs.

Fidelity Spartan International Index (FSIIX) now charges 0.10% in annual expenses. The comparable ETF, iShares EAFE Index (EFA, news, msgs), charges 0.35%. This is a loss-leader for Fidelity -- the fee cuts are estimated to cost the firm $40 million in annual subsidies -- but still a boon for thrifty investors.

And when returns are measured in basis points, or hundredths of a percentage point, every point counts. The market this year, as of Oct. 13, was down 0.11%. The largest actively-managed equity mutual fund, Fidelity Magellan (FMAGX), was down 0.35%.

The S&P Spider, which, unlike the index (but like Magellan), pays a dividend, was up 1.37%. The Spider’s expense ratio is 0.12%. Magellan’s is 0.70%. What are you getting for you money? Less than nothing.

Answer 2

ETF's can be a good foundation for an investment portfolio. I have several in mine and am pleased with the performance, and especially the low fees. Because there are so many ETF's now, it is important to do some research. The attached link will give you a start.

Answer 3

IF you want to invest in the stock market and gain money then ETF's are the safest route to go...unless you are a get rich quick player....the ETF's have the lowest fees and follow the market..Your best best for long term growth!

Answer 4

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Answer 5

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Answer 6

1) Yes.
2) Yes.