Just as digital downloads have revolutionized music and book publishing, exchange traded funds are changing the way people are investing here in the United States and around the world. Like breweries in Central Oregon, ETF’s are experiencing remarkable growth. They have developed into a market worth over $1.75 trillion.¹ Sales of equity ETFs last year hit $122 billion, against outflows of $33 billion from equity mutual funds, according to data provider Morningstar. Russ Koesterich, global chief strategist for BlackRock, believes the industry will grow by up to 30 percent a year “for the next few years.” BlackRock owns the largest ETF company: iShares.
At its most basic, an ETF is an investment fund listed and traded on a stock exchange, and holds assets such as stocks, commodities or bonds that track an index. They are designed to mirror a market index. With over 1,100 different ETFs offered, there is one for practically every index available. In fact, ETFs track nearly twice as many broad-based market indexes as traditional index mutual funds. This creates amazing flexibility in structuring an overall portfolio to the specific needs of any investor. The three most popular stock market indices are the Dow Jones Industrial Average, the S&P 500 and the NASDAQ. The ETFs that mirror these indices are referred to as Diamonds, Spiders and Cubes because their symbols are DIA, SPY and QQQ.
Whether you are a traditional buy and hold investor, or actively trade to profit from shorter-term opportunities, here are some reasons why you may consider their use.
1. LOW COST
I use ETFs extensively in my client’s accounts because of their flexibility and low cost. ETFs often have expense ratios that are a fraction of the cost of an average actively managed mutual fund. The average cost of an ETF is .52 percent while the average cost of a mutual fund is 1.38 percent.¹
2. TAX EFFICIENCY
Due to the unique creation unit process involved with ETFs, they have become one of the most tax-efficient pooled investment vehicles for investors. Historically, only a few ETFs have ever passed on taxable capital gains distributions to investors.
3. LIQUIDITY
Exchange Traded Funds provide the diversification benefits of a mutual fund with the advantage of being traded like an individual stock. Whereas a mutual fund can only be bought or sold based on that day’s closing price- calculated after the markets have closed, Exchange-Traded Funds can be bought or sold anytime throughout the trading day. This allows you to more quickly enter or exit the market during the day.
4. RISK MANAGEMENT
As pooled investments, ETFs expand diversification and ultimately lower risk. Besides many broad-based ETFs, there are also ones targeting specific sectors of the market. Exchange-Traded Funds aren’t just for stock-based investments. There are separate ETFs that invest in bonds, real estate, precious metals and other commodities. There are ETFs designed for growth and others designed for income. Also, ETFs have minimal style drift, making them effective tools for portfolio-level risk management.
5. TRANSPARENCY
ETFs are fully transparent investments. The underlying holdings of each ETF are published daily by ETF providers – in contrast to relatively limited disclosure from mutual funds. The average mutual fund replaces its entire portfolio over the course of a year.
6. INVESTING IN INDEXES- THE ADVANTAGES OF THE PASSIVE APPROACH:
While investors have historically relied upon actively managed mutual funds to achieve diversification and asset allocation, most actively managed mutual funds have under-performed market indices over time. ³ Passively-managed Exchange Traded Funds, on the other hand, have historically provided better performance than the typical mutual fund. In addition, ETFs allow you to take full advantage of the benefits of asset allocation and portfolio diversification, while also giving you the ability to better track market performance.
To summarize, ETFs can be used in many ways. They can be used to round out a portfolio. If you have several individual stocks that you don’t want to sell for tax reasons, ETFs can be used to add diversification. ETFs can be sold short so they can also be used to protect the rest of your portfolio in a falling market. Or ETFs can be used to increase specific exposure of an overall portfolio. For instance, you could have international exposure but overweight Japan by buying a broad-based international ETF and a Japan-focused ETF.
ETFs are reshaping the way people are investing for their financial future. With their numerous benefits, I believe they are worth taking a look at to see where they may play a role in your portfolio.
¹ BlackRock
² Morningstar
³ Russell Indexes Courtesy of Lipper
David Rosell is President of the Rosell Wealth Management in Bend. He is the Past President of the City Club of Central Oregon and a Past Chairman of the Bend Chamber of Commerce. David can be reached at (541)385-8831. You can learn more about ETF’s at www.RosellWealthManagement.com.
This material is intended for informational purposes only and should not be construed as legal or tax advice, or investment recommendations. You should consult a qualified attorney, tax adviser, investment professional or insurance agent about the issues discussed herein.
Investment advisory services offered through Rosell Wealth Management, a State Registered Investment Advisor. Securities offered through ValMark Securities, Inc. Member FINRA, SIPC 130 Springside Drive, Ste 300 Akron, Ohio 44333-2431. 800 765-5201. Rosell Wealth Management is a separate entity from ValMark Securities, Inc.
