Registered Investment Advisor

Scott Burns' Articles -- Recent and Archived
Print Article Email Article

The ETF Revolution - Special Edition

Exchange traded funds are revolutionizing how we invest.

    An exchange traded fund, as the name suggests, trades like a common stock. That means you can buy or sell shares at any time during the day. The difference is that an ETF is a portfolio of stocks (or bonds) that mimics an index. Just as the first index mutual fund mimicked the Standard and Poor’s 500 Index, the first exchange traded fund mimics the Standard and Poor’s 500 Index. Launched in 1993, the SPDR Trust (ticker: SPY) now has nearly $50 billion in assets. That puts it among the ten largest mutual funds. 

    The growth of ETFs has been stunning. When index mutual funds had been around for ten years there were only seven funds. ETFs grew to 108 in the same time period. Today, over 177 ETFs trade in U.S. markets.  More are on the way.

    What makes them so attractive?

    Low cost, liquidity, diversification, and instant ownership. True, you have to pay a brokerage commission to buy or sell ETF shares. But commissions are a trivial expense for many investors.

    Here’s the math. You can buy Vanguard 500 Index mutual fund shares at an expense ratio of 0.18 percent, no load. The original SPDR Trust ETF reproduces the same index and has an expense ratio of 0.10 percent. Do a $10,000 trade with an $8  commission and you’ll recover the commission in 12 months on the expense ratio difference.  After that, you save money.

    You can set up my Margarita Portfolio for $24 in commissions and it will have an average annual expense ratio of 22 basis points (0.22 percent). Named in honor of Jimmy Buffett, not Warren, this portfolio is 1/3 domestic equities, 1/3 international equities, and 1/3 Treasury inflation protected securities. If you can make a Margarita, you can manage this portfolio--- and practicing is fun.

    Speaking at a recent Financial Planning Association conference, planning Guru Harold Evensky told planners his firm had decided to concentrate on instruments like ETFs. It was, he said, the only strategy that would work in the low return environment he is expecting. Only a small portion of client money would be invested in non-index funds.

    Evensky, I think, is on the leading edge of the advisory community. Rather than search for good stock pickers, he’s putting his energy into providing efficiently delivered market returns.

    With nearly 200 ETFs it’s easy to build a diversified portfolio. You can own large, mid, and small cap domestic indices. You can tilt toward growth or value. You can invest in markets as small as Belgium or Hong Kong. You can also invest in specific sectors such as energy, gold, real estate, or pharmaceuticals.

    The most interesting ETF development is the creation of “intelligent” portfolios. This second wave of indexing goes beyond building portfolios that simply reproduce a broad market index.  Instead, the index is constructed with rules that may produce superior performance. The Fundamental Index ETF, based on research by Rob Arnott  and soon to be launched by Powershares , back tests with a long term advantage over the S&P 500 Index of about 200 basis points a year.

    Most portfolio managers would kill or sell their souls for that kind of an edge.


Only published comments... Feb 01 2006, 10:42 AM by scottb
Filed under:


Comments

No Comments

About scottb

Scott Burns has covered the changing world of personal finance and investments for nearly 40 years. Today, he ranks as one of the five most widely read personal finance writers in the country. Scott began his career as a newspaper columnist at the Boston Herald in 1977 where he was also the financial editor. Nationally syndicated in 1981 and now distributed by Universal Press, the column appears in newspapers from Boston to Seattle. In 1985 he joined the staff of the Dallas Morning News where his column quickly became one of the most widely read features in the paper. He left the Dallas Morning News in 2006 to become one of the founders of AssetBuilder and its Chief Investment Strategist. Burns is a graduate of Massachusetts Institute of Technology (1962). He has written four books, including "The Coming Generational Storm" (MIT Press, 2004) coauthored with economist Laurence J. Kotlikoff. His fourth book, also coauthored with Kotlikoff, was published in 2008 by Simon & Schuster. The paperback edition will be available in January, 2010.  "Spend Til' the End" uses consumption smoothing to demonstrate the errors of conventional financial planning. His business experience includes working as a staffer for a major consulting company and service as a director and audit chairman of a NASDAQ listed manufacturing company. He and his wife now live in Dripping Springs, a "hill country" town about 25 miles outside of Austin.


Contact Us

Open Monday-Friday
9 a.m. - 5 p.m. (CST)

ph. 972.535.4040
fx. 214.556.3848
Email Us

1255 W. 15th Street Suite 240 Plano, Texas 75075