The Basics of ETFs

I haven't written a lot about ETFs because I don't invest in them -- at least not now. But this article from Marketwatch on some new developments in ETFs also gives a list of the basics of ETF investments  and I thought it would make a good "basic information" post. The key points:

In just a few years, ETFs have proliferated into one of the hottest items in the investment business, with more than 200 funds trading in the U.S. and commanding over $300 billion in assets. There are funds tracking indexes tied to U.S. and foreign stocks, domestic government and corporate bonds, and commodities such as gold and oil. On deck: international small-cap stocks; municipal bonds, and other specialized sector products.

ETFs are low-cost indexed baskets of securities that trade on exchanges throughout the day like stocks. Their liquidity makes them a handy tool for traders, especially now that many traditional mutual funds discourage short-term activity.

Part of the reason why ETFs hold such appeal are the relatively high fees that mutual funds typically charge. The average actively managed diversified U.S. stock fund carries an expense ratio of 1.52%, versus 0.44% for comparable ETFs, according to investment research firm Morningstar Inc.

High costs create an additional hurdle for fund managers trying to beat a benchmark index, which most have failed to do for the past several years. The S&P 500 Index outperformed almost two-thirds of large-cap active funds in the five years through Dec. 31, according to Standard & Poor's. Meanwhile, the S&P Midcap 400 Index bested 81% of mid-cap managers and the S&P SmallCap 600 Index topped 72% of small-cap managers.

Good, basic information on ETFs. I'm sure some readers out there have thoughts on them -- please feel free to share your comments with the rest of us. What do you like about ETFs? What don't you like? Any advice?

One part of the above I just HAVE to highlight again:

The S&P 500 Index outperformed almost two-thirds of large-cap active funds in the five years through Dec. 31, according to Standard & Poor's. Meanwhile, the S&P Midcap 400 Index bested 81% of mid-cap managers and the S&P SmallCap 600 Index topped 72% of small-cap managers.

Yep. This is why I like index funds. ;-)

Comments

[J.D. @ Get Rich Slowly]

I was just discussing ETFs with a friend this morning. I'm nervous that my initial forays into the stock market have been through direct stock purchases. My pick (GM) is doing well, and I'd like to sell now while I have a 20% profit and move into an ETF index fund, but don't know where to start looking, really. I'm hoping that this article helps to clarify some things!

[FRED KOBRICK]

Hi, FMF, this is Fred:

EFT’s are a great vehicle and I do like them, but like stocks and mutual funds, one has to have a process for buying and holding and selling. The real question I come up with is if you do not want to pick amongst great mutual funds and only want index funds, why would you pick EFT’s that could be harder to buy and sell then some of the world’s best mutual funds?

I realize that I was one of only a handful of managers that beast the market when my 15 year results were far, far above the market and other funds, but I knew that many people found my fund and others in that top 5 and bought and held. I wish more people would learn to do this with mutual funds and stocks instead of copping-out, and that is why I wrote The Big money—I hate to see so many people stuck with retirement problems, including lots of my friends.

If you look at the S&P 500 for this decade, so far, since December 31, 1999, that index is down by almost 10% even after a big rally in recent months. That’s almost 5 ½ years of negative returns for the INDEX FUNDS.

This is in a period when the best stocks and funds have made people some really great money—plenty of people who know just a reasonable amount have far more than doubled their money, and that means regular people like teachers and other non-financial types.

So, I do like EFTs, but like anything else it depends on how one invests in them---as investors and not gamblers I would hope.

I want people to learn some easy basic things about investing and then they will have a far easier time moving from bank accounts and index funds to great mutual funds, EFTs if they wish, and the kind of stocks that make people wealthy for life.