-- In recent years, you’ve probably heard the abbreviation ETF and wondered what it means. These low-cost investment vehicles are definitely something that investors should become familiar with, especially when starting down the road to building wealth.
ETFs aren’t as well-known as mutual funds and most corporate 401(k) plans don’t offer them. That’s a shame because they have some real advantages over mutual funds. First offered in the 1990s, ETFs have gradually grown in popularity to hold $2.1 trillion in assets.
Unlike shares of index mutual funds, ETFs can be bought on the exchanges during the trading day at their current price, just like a stock. Index mutual fund shares, however, can only be bought or sold at the close of the trading day. This flexibility of ETFs gives investors the opportunity to get in or out quickly to seize opportunities or minimize damage from falling values.
This difference can be a both a blessing and a curse. “The biggest advantage of ETFs is the biggest disadvantage,” says Mark Salzinger, editor and publisher of The Investor’s ETF Report, a monthly newsletter on the subject. “So those who invest in them can act like a trader. This seems great on the surface, but it isn’t good for most people because fear and greed can enable a short-term orientation, which can hurt them.”
What Salzinger means is that, while being able to trade ETF shares at the drop of a hat can be a good thing for those with the skill to do it right, it’s not really necessary for many individual investors who are interested in the long term.
Yet, there are other advantages of ETFs that can benefit individuals, especially if they have the discipline not to trade every time they see a big price movement in the indexes to which their ETFs are linked. These advantages include:
Over the long haul, differences in ETF fees can make a big difference in total returns. For example, let’s say you invest $10,000 in two ETFs and add $5,000 a year to these investments for 20 years. Both generate a 10 percent annual return. Over this period, one of the ETFs, with expenses of five basis points (.05 percent), returns $270,000 (over and above the money you invested). The other, with expenses of 55 basis points (.55 percent), returns $238,000. Both ETFs track exactly the same index, so their gross returns are the same. Thus, the only issue is expenses, which has a big impact on net returns over time —a difference of $32,000 in this example.
If you want to get a small measure of commodity exposure at low cost to balance out your overall portfolio—depending on your age, goals and risk tolerance—consider a commodity market ETF that invests across many sectors including precious metals, oil, grains, etc. It’s safer to get exposure that’s broad-based, and such ETFs are widely available with low expenses.
There are also some key caveats for ETF investors:
As with any investment, ETFs have upsides and downsides. But as an asset class, they hold benefits that other types of funds don’t tend to offer.
Any opinions expressed in this column are solely those of the author.
Dave Sheaff Gilreath is a founding principal of Sheaff Brock Investment Advisors LLC. He has more than 30 years of experience in the financial services industry, beginning with Bache Halsey Stuart Shields and later Morgan Stanley Dean Witter. At Sheaff Brock, he shares responsibility for setting investment policy, asset allocation and security selection for the company's managed accounts. He also consults with the clients on portfolio construction. Gilreath received his Certified Financial Planner® (CFP) designation in 1984. He attended Miami University in Oxford, Ohio, where he earned a B.S. degree. He does not own the investments mentioned in this column.