Objective information about financial planning, investments, and retirement plans

What Do ETFs and Youth Soccer Have in Common?


Another sign of spring here in the Chicago area is the appearance of lines on the local youth soccer fields.  All three of our kids played soccer and we still miss watching them play.

So what do ETFs and youth soccer have in common?  From our experience as the parents of three travel soccer players, including one who was a ref for several years, very few parents understand the rules of the game which sadly too often leads to some really bad behavior on their part.  From many of the questions that I get and from what I read many investors don’t understand ETFs all that well either.  This post will attempt to highlight some of the basics of ETF investing for those readers who may be unclear or have a few questions.

(One example of some over the top soccer parents occurred when our now 23 year daughter was playing in a 9 year old game.  Some parents from the other team came over to our side of the field and started a fight.  My wife ended up as a witness in soccer court and two dads ended up being banned from any Illinois youth soccer game or practice for two years.) 



What is an ETF? 

According to the NASDAQ site:

“In the simplest terms, Exchange Traded Funds (ETFs) are funds that track indexes like the NASDAQ-100 Index, S&P 500, Dow Jones, etc. When you buy shares of an ETF, you are buying shares of a portfolio that tracks the yield and return of its native index. The main difference between ETFs and other types of index funds is that ETFs don’t try to outperform their corresponding index, but simply replicate its performance. They don’t try to beat the market, they try to be the market. 

ETFs have been around since the early 1980s, but they’ve come into their own within the past 10 years.”

In simple terms ETFs are essentially mutual funds that trade on the stock exchanges much like shares of common stock such as Apple or IBM.  They are bought and sold during the trading day just like stocks.

While it is true that the first ETFs were index tracking products, actively managed ETFs are coming into play with perhaps the most successful active ETF so far being the ETF version of PIMco’s Total Return bond fund (ticker BOND).

Advantages of ETFs 

ETFs have several features that are advantageous to investors:

  • Most ETFs are transparent as to their holdings.
  • ETFs can be bought and sold during the trading day.
  • Stop orders can be used to limit the downside movement of your ETFs.
  • ETFs can also be sold short just like stocks.
  • Many of the index ETFs carry low expense ratios and can be quite cheap to own.
  • Due to their structure, many ETFs are quite tax-efficient.
  • ETFs provide a low cost, straightforward way to invest in core market indexes. 

Disadvantages of ETFs 

  • ETFs can be bought and sold just like stocks.  In some cases this could cause investors to trade in and out of ETFs when perhaps they shouldn’t.
  • The popularity of ETFs has caused ETF providers to introduce a proliferation of new ETFs, some are excellent, some not so much.  Many new ETFs are based on untested indexes that have only been back-tested.  Additionally there are a number of leveraged ETFs that multiply the movement of the underlying index by 2 or 3 times up or down.  While there is nothing inherently wrong with these products they can easily be misused by investors who don’t fully understand them.
  • Trading ETFs generally entails paying a transaction fee, though a number of providers have introduced commission-free ETFs in order to gain market share. 

All ETFs are not created equal 

Much of the growth in ETFs was fueled by basic index products such as the SPDR 500 (ticker SPY) which tracks the S&P 500 index.  Vanguard, ishares, and the SPDRs all started with products that tracked core domestic and international stock and bond indexes.  The popularity of ETFs grew in the wake of the financial crisis and ETF providers have been falling all over themselves to bring new ETFs to market.

Some of these new vehicles are good, but others track questionable indexes or benchmarks.  These products are essentially made up in a lab, reminiscent of Gene Wilder, Terri Garr, and Marty Feldman in Young Frankenstein.

There is a site with an ETF Deathwatch section listing various ETFs and other exchange traded products that are on life support.  This Bloomberg article comments on some ill-fated ETFs as well.

Free trades are good or are they? 

Fidelity and Schwab most notably have offered platforms that allow commission-free ETF trades for their own branded ETFs and a select menu of other ETFs.  This is fine as long as these are the ETFs that you want to own.  Note I’ve found that several of the Schwab ETFs are very low cost and track core indexes so they can be good choices.

Additionally you can trade Vanguard’s ETFs commission-free if you trade in an account at Vanguard.

At the end of the day you should buy the ETFs that are best for your situation.  This assessment should include the underlying ETF benchmark, the expense ratio, and the liquidity.  If you can trade it commission-free so much the better.

Overall ETFs can be a great investment vehicle for both traders and long-term investors.  As with any investment vehicle it is incumbent upon you to understand what you are buying and how it fits into your investment strategy.

Please contact me at 847-506-9827 for a complimentary 30-minute consultation to discuss  all of your investing and financial planning questions. Check out our Financial Planning and Investment Advice for Individuals page to learn more about our services.

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I use Morningstar extensively for investment research and portfolio analysis in my practice.  While I have subscribed to several of their services geared to financial advisors over the years, I have maintained my premium subscription to morningstar.com.  Click on the banner (also an affiliate link, no extra cost to you) below to get a free trial for their wide array of premium services which includes extensive research and information about ETFs.

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3 Considerations When Opening an IRA Account


As we head toward April 15 it is now high IRA season for the major brokerage and financial services firms.   You will undoubtedly see many TV commercials and ads by these firms touting the benefits of opening an IRA with their firm.  Here are 3 things to consider as you evaluate your best IRA account options.

Understanding your retirement

How much will this cost me? 

Some firms may charge a fee just to have the account.  This might be on the order of $25 or $50 annually.  If your balance is relatively low this can be a significant bite.  Sometimes these fees are based on the size of your account balance.

Additionally you will want to understand any and all transaction fees.  This might include trading fees for buying and selling stocks, ETFs, or other exchange-traded investment vehicles.  Certain mutual funds might carry a transaction cost as well.

If you are working with a commission-based financial advisor understand how he or she is compensated.  Will the funds in the IRA account they are advocating carry sales charges or high internal fees to compensate them?

Is this custodian a good fit with my investing needs? 

This runs the gamut.  Certainly the fees mentioned above are part of this.  Beyond this look at how you invest and the vehicles in which you invest.

For example if you use ETFs extensively does this custodian offer any commission-free ETFs?  If so are these the ETFs that you would use?

As an example if you were planning on using Vanguard mutual funds exclusively it might make sense to house your IRA there.  On the other hand if you were looking to use funds from a variety of families perhaps a custodian that is more of a fund supermarket like Schwab or Fidelity is more appropriate for you.

Beyond an IRA account is this custodian a good fit for my needs in terms of other types of accounts such as a taxable brokerage account?  Do they offer the full array of services that I might need?  In my experience having an IRA at one custodian plus other accounts scattered around several other custodians is rarely a good idea.

Should I roll my 401(k) to an IRA or leave in my old employers plan? 

One of the primary reasons that investors open an IRA during the year is to roll their old 401(k) account over when leaving a job.

If you are leaving your employer whether to roll your 401(k) balance over to an IRA, leave it in your old employer’s plan, or roll it to your new employer’s plan (if applicable) is a critical decision.

There are good  reasons to move your account balance to an IRA which could include:

  • Your old employer’s 401(k) plan is lousy (as is your new employer’s if applicable).
  • A desire to consolidate all of your various retirement accounts into a single IRA to make management of your investments easier.
  • Access to a wider selection of quality investment options than might be available via your old employer’s plan.
  • Perhaps you are working with a trusted financial advisor and the rollover with allow them to better integrate this money with your overall investment strategy. 

On the other hand two reasons to consider either leaving your money in your old employer’s plan or rolling it into your new employer’s plan (if applicable):

  • The plan offers a menu of low cost institutional investments that might not be available to you via a rollover IRA.  This is often the case with very large employers with tremendous buying power, but also with smaller plans who use a competent outside investment advisor.
  • Similar to the last bullet, the plan offers specific investment options that you would be unable to match in an IRA. 

An IRA, either Traditional or Roth, is a great vehicle to help you win the retirement gamble.  Before opening an IRA account you need to do your homework just as with any investing decision.

Please contact me at 847-506-9827 for a complimentary 30-minute consultation to discuss  all of your investing and financial planning questions. Check out our Financial Planning and Investment Advice for Individuals page to learn more about our services. 

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ETF Price Wars: A Good Thing or Just More Hype?


Fidelity has fired another salvo in the ongoing ETF price wars with the introduction of a number low cost sector ETFs.   Schwab, TD, Blackrock, Vanguard, and others have also participated in this price war in one form or another over the past couple of years.  Low ETF expenses and low or no transaction fees are a good thing, but should they be the deciding factor in your decision where to invest?

Walmart on Black Friday 2009

Understand what you are buying 

As we’ve learned from the PBS Frontline special The Retirement Gamble among other sources, low investment costs are a key determinant accumulating a sufficient retirement nest egg.  The first and most important factor in choosing an ETF to include in your portfolio is to understand what the ETF invests in.

An ETF that tracks an index such as the S&P 500 is pretty simple.  However ETF providers are introducing new products seemingly every day.  According to Chuck Jaffe in a MarketWatch article, a Vanguard report found that “1,400 U.S. listed ETFs track more than 1,000 different indexes. But more than half of these benchmarks had existed for less than six months before an ETF came along to track it.”

Beyond commissions and expense ratios 

Fidelity recently published an excellent piece on its site, Beyond Commissions: An ETF’s Price Matters.  According to the article:

“Commissions aren’t the only cost to consider when buying an ETF. Most investors compare expense ratios, but a less appreciated—yet important factor—is the bid-ask spread, which is the difference between the highest price a buyer is willing to pay for an asset (bid) and the lowest price at which a seller is willing to sell (ask). While investors should consider the Net Asset Value (NAV) of an ETF, the price you pay is a seller’s ask price, which can be at a discount or premium to the NAV.

“It’s important to remember that not all ETFs are created equal,” says Ram Subramanium, president of Fidelity brokerage services. “So, investors may want to look for ETFs with established track records and low bid-ask spreads relative to their peers.”

As an interesting aside here, one of the low cost sector ETFs that Fidelity recently introduced was its materials ETF Fidelity MSCI Materials ETF (FMAT).  This ETF competes directly with the Vanguard Materials ETF (VAW) and has an expense ratio of 0.12% vs. 0.14% for the Vanguard ETF.  However the recent bid/ask spread for the Fidelity ETF was 11.68% vs. 1.57% for the Vanguard ETF (according to Morningstar).  The passage above from the Fidelity article might indicate that the older, more established Vanguard ETF is a better choice here.

Other factors to consider

  • Unless you are a frequent trader or you are purchasing ETFs in small dollar amounts trading commissions really shouldn’t be a major factor in your ETF investing decisions.
  • Consider the full breadth of the investment products available to you as well as your investing objectives when choosing an investment custodian.  ETF price wars are much like loss leaders in retailing.  Major custodians such as Fidelity are using low cost ETFs to get you in the door and to hopefully entice you to use their services to invest in mutual funds, stocks, and other investment products via Fidelity.
  • Are the commission-free ETFs the right ones for your portfolio?  For example a number of the ETFs offered on Schwab’s commission-free platform are not ones that I would generally choose for my client’s portfolios.
  • How cheap is cheap?  I doubt that selling one ETF and buying another to save say 0.02% on the expense ratio makes sense, especially if there are transaction costs or capital gains to consider when selling.
  • How well does the ETF track it’s benchmark index?  I’m often surprised by the variations when comparing two ETFs that I would assume to be identical other than the name of the ETF provider.

Are ETF price wars a good thing for investors?  Yes.  Are ETF price wars being used by major custodians and ETF providers to create hype in the financial press in order to lure investors?  Again yes.  The bottom line here is that your financial plan and investment strategy should guide your choice of ETFs, mutual funds, or any investment vehicle, not a slightly lower cost or the lure of free trades.

Please contact me at 847-506-9827 for a complimentary 30-minute consultation to discuss all of your investing and financial planning questions. Check out our Financial Planning and Investment Advice for Individuals page to learn more about our services.   

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5 Things You Should Know About ETFs

English: Wall Street sign on Wall Street

ETFs continue to gain ground as an investment of choice among many individual and institutional investors.  ETFs are similar to mutual funds in that they are pooled investment vehicles and to closed-end funds in that they are traded on a stock exchange like individual stocks.  ETFs, though popular, are often misunderstood by investors.  Here are 5 things you should know about ETFs.

Not all ETFs use conventional underlying benchmarks

The first ETFs were largely index products such as the SPDR S&P 500 (ticker SPY) which tracks the S&P 500 index.  SPY remains one of the most traded ETFs day and day out in terms of volume.

An ETF like SPY is pretty easy to understand.  The underlying holdings mirror the S&P 500 index and performance generally tracks the index less the ETF’s expenses (0.09% according to Morningstar).

With the popularity of ETFs, the growth and proliferation of new vehicles is quite high.  Many of these new ETFs track some “funky” benchmarks.   Market Watch’s Chuck Jaffe cited a Vanguard report that found “1,400 U.S. listed ETFs track more than 1,000 different indexes. But more than half of these benchmarks had existed for less than six months before an ETF came along to track it.”   

I suspect this issue will become more prevalent as ETF providers continue to introduce new ETFs in a bid to capture market share and assets.

Some ETFs are based on fads or gimmicks 

The Winklevoss twins (of Facebook fame) recently announced the proposed launch of a new ETF tracking Bitcoin.  Bitcoin is virtual currency that exists outside of governmental regulation.  The ETF faces many hurdles and may never get off of the ground.

Should the ETF ever become available for trading this would be the ultimate in gimmicky ETFs.  I find Bitcoin itself a bit hard to understand.  An ETF tracking this at best undeveloped market would in my mind be a stretch.  As an investor this is the type of ETF that I would seriously question.

There are any number of ETFs and other Exchange Traded Products (ETPs) that just don’t work out.  You can find many of these on the monthly ETF Deathwatch listing.

ETF Liquidity is complicated.

With stocks liquidity and the trading volume of the equity are closely correlated.  While a thinly traded ETF might result in a little less liquidity the real determinant of liquidity with an ETF is the liquidity of the underlying investments that make up the ETF.

For example the SPDR S&P 500 is made up of the 500 largest domestic stocks.  These stocks are highly liquid and generally all have substantial daily trading volume.

By contrast we’ve seen some fairly wide spreads between the underlying net asset value and the market prices of some emerging market ETFs of late.  This is in large part a function of a lack of liquidity of the underlying holdings of these ETFs.

Not all ETF structures are identical

Vanguard’s ETFs are structured as another share class of their mutual funds in most cases.  Many popular ETFs are structured as open-end funds, others are structured as Unit Investment Trusts (UIT).  Many single commodity ETFs are structured as Grantor Trusts.  Exchange Traded Notes (ETN) are actually debt instruments linked to the performance of a currency, a commodity, or an index.

Each of these structures have different characteristics and these characteristics may have an impact on the tax treatment of gains or distributions.  For example some commodity based ETFs have a different ongoing tax treatment than say an equity-based index ETF.

It is important that you understand any such factors of your ETF or ETN to avoid nasty surprises at tax time or undo risks that may be associated with the product’s structure. 

Free commission ETFs may not be the best deal for you 

Schwab, Fidelity and others are offering a number of ETFs that trade commission free.  That’s a good thing, but before jumping on one these offers make sure the ETFs offered for free are the best deal for you.

The benefit of free commissions can quickly be negated by high ongoing expenses.  Trading costs are relatively low at most online and discount brokers so unless you are a frequent trader this really shouldn’t be a factor in the decision as to which ETFs belong in your portfolio.

Additionally buying an ETF that doesn’t fit your investment objectives just to save a few dollars in trading costs is absurd.

ETFs can offer a low cost vehicle to build a portfolio.  I use index ETFs extensively for their low costs and adherence to an investment style as a key building block in my client asset allocation strategies.

Like anything else, however, it is vital that you understand what you are buying and that you invest in ETFs that are appropriate for your investment plan.

I want to thank local ETF expert Christian Magoon for his contributions to this post. 

Please contact me at 847-506-9827 for a free 30-minute portfolio review consultation and to discuss all of your investing and financial planning questions. Check out our Financial Planning and Investment Advice for Individuals page to learn more about our services.   

For you do-it-yourselfers, check out Morningstar.com to analyze your ETF and all of your investments and to get a free trial for their premium services.  Please check out our Resources page for links to some additional tools and services that might be beneficial to you.  

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Forget Retirement Seek Financial Independence


This is a guest post by author and financial journalist Jonathan Chevreau.  Jon is editor of MoneySense Magazine and the author of the book Findependence Day.  

While the media and the financial services industry seem equally obsessed with the concept of retirement, there is in myFindependence Day Book from Jonathan Cheverau view a better more practical goal: one that is far less intimidating for newer investors just starting on their life and financial journeys.

Financial Independence vs. Retirement

This goal is Financial Independence or the short-form I’ve coined that means the same thing: Findependence. Note that Findependence is NOT synonymous with retirement.

Financial independence can and probably should precede traditional retirement by a decade or two. In these days of clean and healthy living and good prospects for longevity, it makes little sense to take “early” retirement in one’s 50s, if you define what follows as 30 or 40 years of doing little more than watching daytime television, playing golf and sailing.

By contrast, no age is too soon to establish findependence: if you can do so in one’s mid 20s, that’s a good thing, and many technology entrepreneurs have done just that: from Steve Jobs to Mark Zuckerberg to Tumblr founder David Karp, who just sold out to Yahoo at the tender age of 26. The first two did not stop working once their early payday arrived and I’m sure that will also be the case with America’s newest multi-millionaire, Mr. Karp.

What is Findependence?

As I note in my book Findependence Day, Findependence just means that total income from multiple sources – pensions, investments, rental income, employed or part-time work, etc. – exceeds earned income from the traditional sole employer.  I define Findependence Day as the day in the future when this magical moment arrives: henceforth you may continue to do exactly the same thing as before, except that deep down you know that you are choosing to continue to work, rather than feeling that one has no choice but to do so because of financial pressure.

To me, early findependence is a good thing, while early retirement may or may not be. Findependence means having the freedom and flexibility to pursue one’s heartfelt goals and dreams, without having to make financial compromises merely to make ends meet. Ideally, you want to achieve financial independence “while you’re still young enough to enjoy it,” which happens to be the sub-title of the new U.S. edition and e-book version of the book, which came out in April. (See www.findependenceday.com ).

For financial planners and investment advisers, such a paradigm shift would I think benefit their clients: average consumers and investors who use their services. And financial planning is a big component – fully a third – of what I’ve dubbed the Findependence Day model.

The other two aspects are online discount brokerages and index investing: either through index mutual funds or exchange-traded funds. And when I say financial planning, I mean primarily fee-only planning, although it can also encompass fee-based planning at least while clients are in transition from the traditional model to this mode of planning and investing.

In these days of ultra-low interest rates and volatile stock returns, I believe costs matter more than ever. Online or discount brokerages are one way investors can reduce transaction costs, while ETFs and index funds facilitate prudent diversification while minimizing investment management costs. But the third aspect of the model is also important, despite the perception by many that so-called do-it-yourself investors buying their own ETFs at online brokerages are in no need of third-party advice.

It’s true that in these days of online investing and so many online tools, financial blogs and social media, that do-it-yourself investors are more empowered than ever to make more of their own investment decisions. But there’s no reason why they can’t add a layer of financial advice, albeit on their own terms, and I believe the best of all worlds for such investors is through fee-only financial planners, the kind that can be found through NAPFA (the National Association of Personal Financial Advisors.)

In other professions, it’s perfectly natural for consumers to engage lawyers, accountants or physicians on a la carte basis, paying only for services as they are contracted for and provided. It shouldn’t be such a big leap for consumers to view the acquisition of financial advice in the same way, negotiating with the planner for a comprehensive financial plan at such and such a set price, or agreeing to tax and estate planning services on an hourly basis, or perhaps through monthly or quarterly retainers to monitor ETF portfolios and rebalance them yearly.

That to me is what financial independence is all about: a partnership with a financial life coach whose vision of your future findependence is perfectly aligned with their own values and skill-sets. You’re reading this guest article on the blog of just such a professional and I thank Roger for the opportunity. And by the way, the book – which some have described as a financial love story – is set in part in Chicago, which is where the action begins.

Jonathan Chevreau is editor of MoneySense Magazine and can be reached at jonathan@findependenceday.com.  His book Findependence Day  is available at Amazon.com, Barnes & Noble.com and Trafford.com.  Jon is a must follow on Twitter. 

Please feel free to contact me with your investing and financial planning questions.  Check out our Financial Planning and Investment Advice for Individuals page to learn more about our services.  

Ignore These 5 Investing Lessons at Your Own Risk

Little Book of Common Sense Investing

The stock market is in the midst of a 4+ year rally that has led to all-time highs for major market benchmarks.  It’s a bit of a strange rally in that the percentage of U.S. households owning stocks is at historically low levels.  Couple this with the raging market bulls we see on shows such as CNBC and it’s easy to see why many investors are confused as to how to precede.  Here are 5 investing lessons to keep in mind as you move forward.

Risk matters 

The potential downside risk should be a key consideration on how you allocate your portfolio.  This is especially directed at those of you readers over the age of say 45 who are within sight of retirement and certainly those of you who are retired.   Even in a well-diversified balanced portfolio if you haven’t rebalanced in awhile you allocation to equities might be higher than your plan exposing you to more risk than you might be comfortable with.

On the bond side it’s likely that the bond market’s best days are behind us.  While not advocating that you necessarily decrease your allocation to fixed income, this might be a good time to look at reducing the duration in your bond holdings.  Duration is a measure of the impact that a 1% increase (or decrease) in interest rates could have on a bond or a bond fund.  For funds you can find this on the morningstar.com website and elsewhere.

As for you 20 and 30 something’s I’m not advocating that you ignore risk, but I am saying that at your stage of life growth from the amount saved and from how your investments are allocated should be foremost in your mind, especially in your retirement savings strategy.

It isn’t different this time 

Prior to the 2000 market drop investors where touting tech stocks, including many companies with no real business plan or balance sheet.  They said it was different this time, it wasn’t.

Prior to the most recent recession housing was the magic bullet.  Real estate was the great hedge.  It wasn’t.

I’m not sure what is being touted as different this time, perhaps its all of the talking suits on TV telling us that it’s OK to increase our equity exposure even in face of these market highs.

The point is to let your own good common sense and an up-to-date financial plan be your guide to a reasonable investment strategy for your situation.  Ignore the hype.

Costs matter 

The deleterious impact of investment fees and expenses has been well-documented in the press of late, and were highlighted on the PBS Frontline show The Retirement Gamble.  The financial press is right.

  • Index funds and ETFs can be a great choice for your portfolio, but make sure that you are buying the lowest cost index product that covers the area of the market that you are seeking to invest in.
  • If you use actively managed mutual funds, make sure the added expense is justified by value added by the manager.
  • As many funds offer multiple share classes try to buy the lowest cost share class available to you.
  • If you work with a financial advisor understand how he or she is compensated and the true cost of your relationship with this advisor.  Besides high fees you want to understand if the compensation structure subjects you to potential conflicts of interest in terms of the financial products that the advisor might suggest for you.

Inflation is your enemy 

Inflation has been pretty benign in recent years but it won’t always be this way.  Even a relatively tame level can erode your purchasing power pretty quickly in retirement.  For example at 3% inflation your purchasing power will be cut in half within 24 years, a very likely life expectancy for a retiree today.  As I often say to those at or near retirement, your biggest investing risk comes from inflation versus the risk of actually losing money from your investments.

You have to play to win 

As I mentioned above the percentage of U.S. households holding stocks is at historically low levels.  What this means is that many families have not participated in this stock market rally.  While I am clearly not advocating that investors jump in to ensure they don’t miss any further gains, I am advocating that if you don’t have a financial plan in place get one done.  You can then gauge how to allocate your investment dollars as an outgrowth of your financial plan.  Jumping out of stocks when the market is at a low point as too many investors did in late 2008 and early 2009 and then jumping back in at a time like the present when it “feels good” is a recipe for fiscal disaster.  This is the value of having a plan.

Please feel free to contact me with your investing and financial planning questions.  Check out our Financial Planning and Investment Advice for Individuals page to learn more about our services.  

For you do-it-yourselfers, check out Morningstar.com to analyze your index mutual fund and ETF options and to get a free trial for their premium services.  Please check out our Resources page for links to some additional tools and services that might be beneficial to you.  

Photo credit:  Wikipedia


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Investing: Even Indexing Takes Work

INDEX IIM Lucknow Logo

The benefits of low-cost index mutual funds and ETFs are all over the news.  They were front and center in the recent PBS Frontline Special The Retirement Gamble.  Index funds are a great tool for investors of all ages; in many cases these passively managed funds beat the majority of their actively managed peers within the same investment style.  However, investing in index funds takes work, especially with the proliferation of new index products that continue to hit the marketplace.

Expenses matter 

Costs matter when investing.  One of the biggest lures of index fund investing is that many of these products provide a low cost way to investment in a given segment of the market.  If you are looking for an index fund that mimics the S&P 500 there are many great low cost alternatives such as the Vanguard 500 Index Fund (Ticker VFINX) with an expense ratio of 0.17% or the SPDR S&P 500 Index ETF (Ticker SPY) with an expense ratio of 0.09%.  On the other hand, there is also the Rydex S&P 500 A (Ticker RYSOX) with its expense ratio of 1.51%.  How big of a deal is this difference?

A $10,000 investment in the Vanguard 500 fund made on May 31, 2006 and held until May 15, 2013 would now be worth $15,064.  That same investment in the Rydex S&P 500 fund would be worth $13,798 or 9.2% less for an investment in a mutual fund tracking the same index as the Vanguard fund. 

Understand the underlying index 

In the wake of the 2008-2009 market downturn new index products, especially in the ETF space, have proliferated.  ETF providers are falling all over themselves to bring new index products to the market hoping to attract assets.  Like any investment, investing in an index fund or ETF requires that you understand what it is that you are buying.

When I think of indexing I think of the traditional, basic index products that track benchmarks such as the S&P 500, the total U.S. stock market, the total non-U.S. market, the domestic bond market, etc.  Additionally I typically use index funds to benchmark the U.S. small and mid cap equity spaces, real estate, and emerging markets equity among others.

Several months ago Market Watch’s Chuck Jaffe cited a Vanguard report that found “1,400 U.S. listed ETFs track more than 1,000 different indexes. But more than half of these benchmarks had existed for less than six months before an ETF came along to track it.”  

As an investor this should be a huge red flag.  What this study says is that many of these new index products were developed much like the monster in the Mel Brook’s classic Young Frankenstein.  Look back-testing is not inherently bad and many of these new index products are appropriate for professional traders.  However if you are looking to index in the fashion that Vanguard founder John Bogle and others espouse then you should consider sticking with index products that track known, battle-tested market benchmarks.

Asset allocation is still vital 

Whether you use index products as a portion of your overall portfolio in conjunction with other investment vehicles such as actively managed mutual funds or individual stocks, or if you invest in index funds exclusively you still need to develop and asset allocation for your portfolio.  As I say frequently on this blog, this should be done as an outgrowth of your financial plan.

Even a seemingly simple strategy of investing in a total U.S. stock market fund, a total international stock market fund, and a total bond market fund still requires that you determine how much to invest in each fund, that you monitor your allocation and rebalance when needed, and that you review and adjust your target allocation as you age or if your situation changes.

Index funds and ETFs are a great investment tool.  Like any tool it is important that you select the right index product and that you manage your portfolio properly.

Please feel free to contact me with your investing and financial planning questions.  Check out our Financial Planning and Investment Advice for Individuals page to learn more about our services.  

For you do-it-yourselfers, check out Morningstar.com to analyze your index mutual fund and ETF options and to get a free trial for their premium services.  Please check out our Resources page for links to some additional tools and services that might be beneficial to you.  

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ETFs or Mutual Funds? – Why Not Both?

Diversification - Investing

Over the past several months I’ve read a number of articles along the lines of “ETFs vs. Mutual Funds.”  In most cases these articles take an either or position which is generally in favor of ETFs.  While I am a fan of ETFs and use them extensively in client portfolios, my question is why do we need to choose between ETFs and mutual funds?  Why not use both?

Looking over the portfolios of my individual clients I could not find one that did not include both ETFs and mutual funds.  In addition some include closed-end mutual funds as well as individual stocks.

Advantages of ETFs  

Originally ETFs were introduced as a way to trade various stock market indexes.  The S&P 500 SPDR (ticker SPY) just turned 20 and is generally at or near the top of the list in terms of ETF trading volume.  The availability of low cost ETFs across a variety of equity and fixed income indexes has mushroomed over the years.  As a financial advisor I use them extensively for their style consistency, low cost, and in many cases their consistently above average performance within their style peer groups.

Especially after the 2008-09 financial crisis the number of ETFs offered has mushroomed and so has the variety of offerings.  Actively managed ETFs are growing and the success of PIMco’s ETF version (ticker BOND) of its popular PIMco Total Return (ticker PTTRX) mutual fund will undoubtedly spur further growth here.

Why bother with Mutual Funds?

In looking at mutual funds you have to divide them into actively managed funds and passive (index) funds.

If you are indexing all or part of your portfolio you want to look at various factors in making your decision as to whether to go with a mutual fund or an ETF.  These include:

  • The size of your account/portfolio.  Even in the world of index mutual funds there are some lower cost versions available to investors who can meet higher minimum investment thresholds.  Vanguard is a good example here.
  • Cost to own.  The expense ratio should be the main factor, but transaction costs can come into play.  While the availability of no-transaction fee ETFs is growing, the ETF you want to buy may not be on this menu at a given custodian.  Likewise some mutual fund families might incur a transaction fee at certain custodians.
  • How will you invest?  If you are dollar cost averaging into a fund/ETF at say $250 per month you’ll want to look for options with no transaction costs.

While actively managed mutual funds get a bad rap in the press, there are still a number of well-managed reasonably priced funds across equity and fixed income styles.  A Schwab study a number of years ago touted a “core and explore” approach to investing.  This meant that the core of the portfolio would be index funds, with the use of actively managed funds in certain asset classes where good index products were not available.

Given the expansion of indexing to a wide range of assets classes in both the ETF and mutual fund format this approach in its original form may be passé.  However I still use a number of actively managed funds across both individual and institutional portfolios.

In choosing an active fund I’m looking for some or all of the following:

  • Long-term outperformance.
  • Superior risk-adjusted performance.
  • Consistency of management.
  • Something that I can’t find in an index product that adds to the overall quality of the portfolio.

Certainly there are a lot of mutual funds that don’t belong in your portfolio.  Loaded funds, proprietary funds from various brokerage houses and other high fee alternatives put a lot of money into your broker/registered rep’s pockets.  Go with no load funds and always shop for the most competitive share class available to you in terms of expense ratio.

Why exclude either ETFs or Mutual Funds?

My point here is not to argue the merits of either mutual funds or ETFs, or for that matter active management vs. passive.  Certainly I’ve seen some excellent examples of portfolios that are all ETF and/or all index products.

However why limit yourself and feel that you need to avoid funds or ETFs?  There are so many choices out there, I feel that I owe to my clients to look at the whole universe of ETFS, mutual funds, and other products that might enhance their portfolio and help them to achieve their investment goals.  In building a portfolio I suggest that you take the approach of picking the best investing vehicles for the various allocation “buckets” in your portfolio whether they be ETFs, mutual funds, actively managed, or passive index products.

Please feel free to contact me with your financial planning questions.  Check out our Financial Planning and Investment Advice for Individuals page for more information about our services.   

For you do-it-yourselfers, check out Morningstar.com to analyze your mutual funds, ETFs, and all of your investments and to get a free trial for their premium services.

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ETFs – 4 Considerations Before Buying


English: You may have heard enough of bad news...

ETFs (Exchange Traded Funds) are the  “hot” investing product. Fund companies are tripping over themselves to bring new ETFs to the market place.  This reminds me a lot of the mid to late 90s and the proliferation of new mutual funds.  While the number of ETFs is lower, the growth in new products is still high.

Traditionally most ETFs have been index products.  The new frontier is actively managed ETFs.  Several providers have filed for approval to offer active ETFs, no doubt buoyed by the success of the ETF version of PIMco’s popular Total Return bond fund (tickers BOND for the ETF and PTTRX for the fund).

I have been a big user of ETFs in the portfolios of my individual clients.  To date I’ve used index ETFs exclusively.  The low cost and style purity are the big selling points in my opinion.

Just as with mutual funds or any other investment vehicle, investors need to do their homework before buying an ETF.  Here are 4 factors to consider:

Understand the ETF’s underlying index

Beware of ETFs with somewhat suspect underlying indexes. According to Chuck Jaffe in a MarketWatch article several months ago, a Vanguard report found that “1,400 U.S. listed ETFs track more than 1,000 different indexes. But more than half of these benchmarks had existed for less than six months before an ETF came along to track it.” 

Many of these new ETFs rely on the hypothetical back-testing of these new indexes. While history is not always a good predictor of future performance, I like to see an ETF with an underlying index that has been “battle tested” in the real world.

Even among ETFs tracking more traditional indexes there can be differences.  For example in the Large Cap Growth style:

  • iShares Russell 1000 Growth ETF (IWF) tracks the Russell 1000 Growth Index, the growth slice of the Russell 1000 Index.
  • Vanguard’s Growth ETF (VUG) is in the process of switching index benchmarks as part of an overall switch of benchmark providers by Vanguard across many of its index mutual funds and ETFs.  The new provider’s index will remain a bit different from the Russell index used by the Barclay’s ishares product.
  • The Schwab U.S. Large Growth Index (SCHG) tracks Dow Jones U.S. Large-Cap Growth Total Stock Market Index, with a smaller market cap than the benchmark index of the other two ETFs. Additionally the Schwab ETF has higher weighting in financial stocks than most other Large Growth indexes.

To most investors these are fairly subtle differences, but none the less each of these Large Growth ETFs will exhibit slightly different performance during different market conditions.

Leverage and inverse indexing

Not all ETFs make sense for all investors.  There are a number of ETFs that move inversely with a given benchmark.  For example there are ETFs that move in the opposite direction of the S&P 500 index.  What many investors fail to understand is that these movements are tied to the markets on a daily basis, over longer periods of time the performance may not be as closely tied to the inverse performance of the index due to the use of derivatives in these products.

Leveraged index ETFs are available both long and inverse.  These ETFs multiply the movement of the index both up and down.  This is great if you’ve “bet” in the right direction.  However if for example you hold a leveraged ETF that goes 3 times inverse of the S&P 500 Index during a  market rally the ETF will drop in value roughly 3 times as much as the gains on the S&P 500.

There is nothing wrong with either inverse or leveraged ETFs as long as you understand how they work, when and when not to use them, and are comfortable with the risks.  In my opinion these products are not appropriate for most individual investors.

Know what you are buying 

With the advent of “funky” index products as mentioned above and with the growth of actively managed ETFs, investors really need to understand where they are investing their money more than ever.

ETF providers are just like mutual fund providers (in fact many firms offer both) in that they are about gathering assets and making a profit.  There is nothing wrong with this, but make sure that you invest based upon your needs and unique situation and that you ignore their hype, especially about “new and better” ETFs. 

Cheap is good 

One of the great features about ETFs has generally been their low expense ratios.  Just as with mutual funds and any other investment vehicle the cost of ownership is critical, cheaper is better.

Along these same lines there is an ETF price war going on.  The major players are Vanguard, Barclay’s (via their ishares), and Schwab who is trying to make inroads into the ETF business. It is key to make sure that the ETF product fits your needs and your portfolio, don’t just opt for the lowest expense product.

It is also important to note the transaction fees involved in buying ETFs.  Remember ETFs trade like stocks during the trading day as opposed to mutual funds which trade daily after the market close.  A number of custodians offer no transaction fee trades for certain ETFs.  Look at how you will be investing. Will you make larger lump-sum purchases? If so, paying a transaction fee for an ETF really won’t make much of an impact. However, if you will be making smaller purchases, say via dollar-cost averaging, it pays to look around.

Do you use ETFs?  Please leave a comment about your experiences with ETFs both good or bad.

Please feel free to contact me with your financial planning and investing questions. 

For you do-it-yourselfers, check out Morningstar.com to analyze your ETFs and all of your investments and to get a free trial for their premium services.  Please check out our Resources page for links to some additional tools and services that might be beneficial to you.

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Index Funds: Know What You Are Buying


The financial press and many financial advisors advocate the use of index mutual funds and ETFs in your portfolio.  I concur.  Index funds offer many advantages:

  • Low costs
  • Style purity
  • In many cases, better performance than a majority of actively managed funds within the same investment style.

In a recent study, Morningstar indicated that one of the key predictors of a fund’s success is low expenses.  I use index mutual funds and ETFs extensively across my practice for the reasons listed above.

That said, like anything else in the investing realm, picking the right index fund takes some work.   Here are a few thoughts to consider as you go forward.

Low expenses are critical.  Let’s take a look at two funds tracking the popular S&P 500 index.

Fund Ticker Cumulative Return Annualized Returns Growth of $10,000
Vanguard 500 Index Inv VFINX 28.84% 2.21% $12,885.29
Principal Large Cap S&P 500 Index A PLSAY 19.01% 1.51% $11,903.55

The above chart, taken from information from Morningstar assumes the investment of $10,000 in each on 12/31/2000 and that the funds were held with all distributions reinvested through 7/31/2012.

While the returns on both funds are anemic, the difference between these two funds which track the same index and should have virtually identical portfolios is their expense ratios.  The Vanguard fund sports an expense ratio of 0.17% while the Principal funds expense ratio is 0.62%.  The difference in dollars accumulated is about 8.3% between the two funds.

What index does the fund track?  

Let’s look at some popular ETFs in the Mid Cap Blend style:

Name Ticker Avg. Market Cap $ millions Index Tracked
ishares Russell Mid Cap Index IWR 6,906 Russell Mid Cap
SPDR S&P 400 Mid Cap MDY 3,354 S&P 400
Vanguard Mid Cap Index VO 6,138 MSCI Mid Cap 450

All three of these ETFs are solid choices but they follow different indexes with somewhat different characteristics.   For example the smaller average market capitalization of the SPDR product means that it will outperform the other two ETFs during periods where smaller stocks lead the market, as happened over the five year period ending July 31.  By contrast during the three year period ending July 31, larger stocks outperformed, and as such the SPDR product trailed the other two ETFs.

Does the index make sense?  Recently Chuck Jaffe wrote an excellent piece on Marketwatch.com entitled “These ETFs get an “F” for fiction” in which he was critical of the proliferation of new index ETFs based on questionable underlying indexes.  Jaffe cites a recent study by Vanguard indicating that there were 1,400 U.S. listed ETFs that tracked about 1,000 different indexes.  The report further concluded that over half of these indexes existed for six months or less prior to the inception of an ETF designed to track it.

What does this mean for you as an investor?  It means that you may be buying into an index product that has only been tested “in the lab” so to speak.  This reminds me of the mid to late 90s when I made a career switch into the financial advisory world.  At that point in time mutual funds were proliferating at the same rate as the Duggar family (of TLC fame).  Many of the new funds made little sense from an investment standpoint and were brought to market to capitalize on the Bull Market of that time period.  Fast forward to today and we are seeing much the same thing with ETFs, the popular investment structure of this day.  Fund companies want to ride the wave here and can’t seem to get new ETFs to market fast enough.

Tom Lydon, editor of ETF Trends is quoted in Jaffe’s article:

“You’ve got about 1,400 ETFs today, and about 95% of the money invested is in the largest 10% of those funds,” Lydon said. “You have plenty of choice, and you’re not really missing out on anything if you don’t buy the newest ETF out there. … If you see some creative new index with an ETF, watch it for awhile. Maybe it turns out to be something you want to own, but you don’t need to take the risk and jump in right away, when they’re saying the strategy is proven but you know it’s really not.”  

Here are a few tips when considering an index mutual fund or ETF:

  • Rule number one, low cost is good.  This is also rule numbers 2-10.  Paying up for an index fund, in my opinion, makes no sense whatsoever.
  • I tend to stick with more mainstream indexes for my clients.  I am an asset allocator and I want to have an understanding of the type of performance that I can expect over various market conditions.  We may not like that results (as in 2008) but they were not unexpected based on market conditions.  With some of these new, back tested only, index products it is hard to tell how they will react under real market conditions.
    • In short, understand the underlying index of the fund and how it fits with your other holdings.
  • Buy right.  By this I mean look at how you will be investing.  Will you make larger lump-sum purchases?  If so paying a transaction fee for an ETF or for a Vanguard fund if investing someplace other than Vanguard (Schwab for example) really won’t make much of an impact.  However, if you will be making smaller purchases, say via dollar cost averaging, it pays to look around.
    • At Vanguard, once you meet their minimums, additional investment amounts are fairly low for their mutual funds.  Additionally you can buy their ETFs with no transaction costs.
    • Fidelity offers a number of ETFs without a transaction fee.
    • Schwab has developed their own series of index ETFs for which there are not transaction fees for Schwab account holders.  I use some of these ETFs for smaller purchases for some clients.
    • As with anything, please check on any restrictions at these or other firms offering similar deals.
  • Many 401(k) plans offer index funds as a choice.  In some larger plans participants may be able to reap the plan’s buying power and have the opportunity to buy ultra low cost institutional index funds.
  • Vanguard is a prime example here, always make sure you are in the lowest cost share class that you are eligible for.

Index funds can be a great choice for your portfolio.  Always fully understand what you are buying and why you are buying it.

Please feel free to contact me with your investment and financial planning questions.


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