In a full-page ad in the Wall Street Journal, Ameritrade pictures two golf bags. One bag contains only one club and is labeled "stock." The other contains the full complement of drivers and putters and is labeled "ETF," for Exchange Traded Fund.
Even people like myself--- tragic souls born without the Golfing Gene--- know enough about the game to get the message. Ameritrade is telling us that you can play a better investing game with a diversified bag than with a single stock bag.
Their suggestions don't stop there.
In a lengthy text message titled "Managing Estate Planning with ETFs" the brokerage firm suggests, "If you have accumulated significant assets in your retirement accounts, you can roll them into a 'stretch IRA' that allows you to extend withdrawals over several generations." (You can do this by naming a child or grandchild as a contingent beneficiary of the account. This will allow your surviving spouse to calculate withdrawals based on the longer combined life expectancy of spouse and the much younger child/grandchild. Result: your IRA money can grow tax-deferred, with modest distributions, for generations rather than years.)
What investments do they suggest for what should be called your Personal Dynasty Account?
You guessed it: low cost, low turnover Exchange Traded Funds. ETFs, in case you haven't heard, are open-end index funds that trade like common stocks. Currently, there are 126 ETFs. They track a variety of indices for the domestic stock market, including specific sectors like energy, healthcare, and technology. Other ETFs track groups of markets such as emerging markets or Europe. Others track individual countries, such as Japan or France. A small number--- six--- track fixed income indices, such as the short, medium and long term Lehman bond indices and Lehman TIPS index.
Invest in one of the broader indices--- such as the Vanguard Total Stock Market VIPERS (ticker: VTI) and you'll own the entire U.S. stock market at an annual expense of 0.15 percent. Indeed, the original SPDRs Trust (ticker: SPY) invests in the S&P 500 Index stocks and has an expense ratio of only 0.12 percent. Its new competitor, the iShares S&P 500 fund (ticker: IVV) has an expense ratio of only 0.09 percent.
We're talking cheap, really cheap.
Ameritrade concludes, "Over time… the low management fees that make ETFs so efficient will make their performance far superior to that of a comparable, but more expensive mutual fund."
Those are words I never thought I would read in a brokerage ad.
But lets take the whole question a little further.
According to the Morningstar mutual fund database, the average tenure for a domestic equity fund manager is 4.6 years. It's the same for international equity funds. It's 5.2 years for taxable bond funds. If you are investing with your dynastic children in mind, you're thinking about 50 years. It will be even longer if you're thinking about grandchildren.
So ponder. If portfolio managers change every 5 years or so, someone will be trying to make 10 good manager guesses to achieve superior performance over the next 50 years.
What are the odds that someone will do better than a broad index mutual fund or ETF?
Here's the math. Abundant research and history show that a broad index fund is likely to do better than about 70 percent of its more expensive managed competitors. At this moment, for instance, the Vanguard Total Market fund has done better than 69 percent of the competition over the last 5 years--- and that's its worst performance figure. The 10-year figure is better than 71 percent of its competitors; the 3-year figure is better than 84 percent of its competitors.
So your as-yet-unnamed-expert has about a 30 percent chance of better performance with the first selection. At the second selection, the chance drops to 9 percent (30% x 30%). By the third selection the probability is down to 2.7 percent, and so on. Basically, the 50-year probability is zip--- and that's assuming your fund selector doesn't charge an annual percent of assets fee for his brilliance. Add a mere one percentage point annual fee and your dynastic money is dead meat.
Will we see this argument continued in a future Ameritrade ad?
Not likely. But if you think long term, whether it's 25 years or 50, index investing is the way to go. Exchange Traded Funds, like traditional index mutual funds, can help us do it.
This article contains the opinions of the author but not necessarily the opinions of AssetBuilder Inc. The opinion of the author is subject to change without notice. All materials presented are compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. This article is distributed for educational puposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, or service.
Performance data shown represents past performance. Past performance is no guarantee of future results and current performance may be higher or lower than the performance shown.
AssetBuilder Inc. is an investment advisor registered with the Securities and Exchange Commission. Consider the investment objectives, risks, and expenses carefully before investing.