The Fix The Investments Series
By 1993, when State Street Global Advisors introduced us to the world of SPDRs, the exchange traded fund structure, or very similar structures, had already been around for a number of years. The passive investing fuse had already been lit in the early seventies, led by pioneer innovators like Jack Bogle.
One could not wish for a greater disruptive force to come along, and personal investing would never be the same.
Investors showed a voracious appetite for these new and better vehicles from State Street, and in no time, Barclays, Vanguard and other of the “big boys” jumped in. In the 25 years since the inception of the first SPDR, ETFs have swelled to over $5 trillion today, and for many compelling reasons.
With every passing year, ETFs have eaten into managed mutual funds’ market share. So much so that some of the managed fund giants have moved into the passive space as a survival strategy. The winds of change threatened to blow them off the map. The introduction of ETFs has brought us an abundance of profound improvements over mutual funds.
…the introduction of ETFs has brought us an abundance of profound improvements over mutual funds…
ETFs are cheaper
Do ETFs have 5.75% front end commission like mutual funds? No.
Do ETFs have high internal expenses and 12(b)1 fees passed on to the investor like mutual funds? No.
Do ETFs have high portfolio turnover that leads to exaggerated trading costs which get passed on to the investor like mutual funds? No.
Do ETFs present you a tax bill every year for capital gains distributions, even if your fund lost ground like mutual funds? No.
Cost savings are enormous, compared to managed mutual funds. The bottom line is that ETFs keep more money in your pocket and portfolio.
ETFs are transparent
What’s in your managed mutual fund? Do you know? Many times, mutual fund investors are simply unaware which securities are in their portfolio, how much the manager holds, if they are over- or under- weighting a position, or simply holding on to a loser they expect to turn around, but never does. Oftentimes, nervous managers will completely go off the script and by a hot sector to juice up returns. That means, a large cap manager will buy a mid cap stock because his portfolio is failing and mid-caps are hot, and investors are not aware.
ETFs trade closely to their actual NAV, or net asset value, and you can see the actual price in real time throughout the trading day. No need to wait until the next day to see what happened to the price and your portfolio. ETFs offer the immediacy of information that both traders and long term investors want as they make their portfolio decisions. What you see is what you get!
ETFs are tax efficient
Passive ETFs track indices, and the portfolio does not change unless the index has a change of constituents, the individual companies that make up the index. While the vast majority of ETFs are passive, active ETFs have been introduced in recent years, and tactical ETFs from management firms like Wisdom Tree take passive investing in a plausible new direction.
Due to almost non-existent portfolio turnover (buying and selling) and no annual capital gains distributions, you can save a bundle on income taxes. And ETFs have become the preferred vehicle for long term investing strategies in your ROTH or IRA.
…ETFs keep more money in your pocket and portfolio…
ETFs track the indices tightly
There is absolutely no style drift or asset class drift. If a blend of large cap value and growth are what you are after, then either the SPDR S&P 500 ETF Trust (SPY) or iShares Core S&P 500 (IVV) will not disappoint. The objective is fixed, they cannot change course on you, and you get what you expect. This is true of all exchange traded funds tied to an index.
As previously mentioned, it has long been a problem in the managed mutual fund industry for weak managers to chase returns by moving away from their stated objectives. In other words, when a weak small cap manager is in trouble, and their job is on the line, they might chase a hotter part of the market, say mid-caps, to juice their published returns. This cannot happen with passive ETFs.
If you are investing with an objectives-based, asset allocation approach, as most investors should, these potentially harmful, invisible and unexpected changes in navigation can wreak havoc with your risk and return profiles.
ETFs offer high liquidity and marketability
In other words, they can be bought and sold just like stocks throughout the trading day. There are no “blind redemptions” when you sell your shares, hoping and praying the NAV holds up until 4:00.
ETFs have become the chameleons of the investing world
Investors love ETFs for their ability to efficiently manage a small and simple portfolio that provides access to the entire global marketplace, and offer an inexpensive way to under- or over-weight specific sectors of their portfolio.
Traders love ETFs for their ability to enter and exit entire industries or sectors quickly, just as easily as if it were a single stock.
Long term investors and short swing traders are on different sides of the fence when it comes to expectations, objectives and holding periods, so the rise of ETFs as a trading vehicle has brought some unwanted volatility. But volatility is everywhere, and ETF volatility should have come as no surprise to anyone. Traders have never kept investors away from the stocks they like, and traders do serve a purpose in the overall marketplace.
So to be a successful long-term passive investor you need to factor volatility into your plan. Embrace it rather than escape it. Volatility is the difference between the highs and the lows, whether it be a day or a decade, and in the long run, that, along with patience, is what makes us money!
So put down those curds and whey and start researching all that exchange traded funds have to offer!