An ETF Portfolio Could Be The Answer
An ETF portfolio can be a great way to navigate the crowded universe of mutual funds. With over 10,000 funds now available, it's hard to know what to buy and what to sell. Which ones are going to be the best ones to own? How can a person pick mutual funds that they know are going to out-perform the rest of the market? Mutual funds can also be difficult for a variety of reasons. They include: 1. Taxes 1. Taxes. Let's start here. Most people don't even think about taxes when choosing a fund to invest in. But the fact is, the amount of taxes you have to pay on an investment each year can have a huge impact on your bottom line. Traditional mutual funds (the actively managed kind) are tough in that they can generate a lot of taxable income on an annual basis. The fund managers of traditional mutual funds are constantly buying and selling securities inside the fund. Any gains that are realized are passed along to you as the shareholder. Even though you didn't do anything during the year, you get taxed on capital gains distributions made to you during the year. Now this doesn't necessarily mean that you made money. You could have bought into the fund a day before the distribution was made, and therefore you get taxed on it. An ETF however is very tax efficient. ETF's are basically index funds. They are designed to track the performance of a particular index. The fund manager buys all the stocks that represent that index, and then pretty much leave them alone. This reduced amount of internal trading greatly reduces the taxes you have to pay each year, and increases your returns. 2. Transparency. The transparency of an ETF is much greater than a traditional mutual fund. Mutual funds report their holdings every 6 months to shareholders. ETF's report on a daily or monthly basis. This means that it's much easier to see if your portfolio of ETF's has overlaps in sector exposure. The holdings of a mutual fund that are reported are so old that by the time you get them, they don't mean anything. When you invest in ETF's, it's easy to know what you own. You know that the holdings reports are fairly current, which makes it that much easier to diversify your portfolio.
Wrong. Did you know that the majority of actively managed pension and mutual funds UNDER-perform the stock market indexes over time? That's right. Why didn't you know that? Because the mutual fund companies are smart. They highlight and advertise each quarter the ones that are currently OUT-performing the market. They quietly don't mention all the others that are doing horribly. In addition to marketing, fund companies are notorious for closing down mutual funds that have been dogs for a long period of time. They usually merge them into another successful fund, virtually erasing the bad track record of the dead fund. This is known as survivorship bias, and it's a pretty nifty little trick they use. ETF funds are index funds. They basically buy and hold the stocks that represent an index. Their performance will generally track that of the index, minus the management fees (which are fairly small). If your portfolio can just keep pace with the major indexes, you will OUT-perform about 95% of your friends and family over time. Go From ETF page back to HOME page.
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3. Fees. This one is a lot more obvious to most people. But do you really know what kinds of fees you're paying inside your mutual funds. Mutual funds have fees called loads, expense ratio's, & 12b-1 fees. Expense ratios alone typically range from .75% to 1.5% per year. Exchange traded funds don't have loads or 12b-1 fees and the expense ratios that are usually about .3% to .5% per year. This is less than half of what you would normally pay inside a traditional mutual fund. This difference alone can add up to a huge number over the long term. Internal expenses and fees are a source of friction that slows down the performance of your portfolio.
4. Commissions. Many mutual funds have commissions that you pay when you buy them or sell them. This is how the broker who sold them to you gets paid, and they are generally pretty steep. But these are not the kinds of commissions we're talking about here. This is something that most mutual funds won't ever talk about or tell you, but it's true. When a fund manager trades a stock inside a mutual fund, he has to pay a commission for that trade. These commissions are not included in the expense ratio or management fee of the fund, and they can add up to a hefty amount over the course of a year. Morningstar reports that these internal trading commissions can be as high as 2% of the funds assets per year on a very actively traded fund. The best way to check for this in the funds turnover ratio. This tells you the percentage of the funds assets that are traded, or turned over, each year. Since ETF's are index funds, they have very minimal internal trading going on. This again will increase your own returns.
5. Performance. When most people think of mutual funds they think of highly skilled fund managers and team of analysts helping them manage their money. And you would think that the best and brightest minds on Wall Street ought to be able to out-perform the market indexes pretty easily, right?
