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The perfect all-ETF portfolio But are ETFs really better than good old index mutual funds?
Paul B. Farrell], MarketWatch Last Update: 8:20 PM ET Feb. 6, 2005
ARROYO GRANDE, Calif. (MarketWatch) --Most of the time I'm a happy-go-lucky optimist. But when I see Joe and Jane Main Street getting conned again, something flips. Suddenly, I'm swallowing a curmudgeon pill, getting grouchier and grumpier than Andy Rooney.
A reader tells me exchange-traded funds are a better deal than index mutual funds in our "lazy" portfolios. Bah, humbug!
Lazy portfolios are diversified holdings of no-load index funds. They make money in bull markets and protect it in bear markets. They help passive investors who have full-time jobs and don't watch cable TV's talking heads guessing about markets and the economy.
The fact is that a very small percentage of America's 95 million investors are active traders. The rest would be wasting money by paying brokers' commissions to buy ETFs. No-fee mutual funds do a better job. So here are the crusty curmudgeon's three rules for ETFs:
If you're an average investor, never buy an ETF.
If you're a full-time active investor, buy ETFs. But remember you're helping your broker make payments on his BMW.
If you have an uncontrollable urge to buy ETFs, then I'll help you buy the right ETFs and build a winning lazy portfolio.
Are you really being conned? Yes. ETFs are great on paper because operating expenses appear lower. But, in practice, broker's commissions can kill returns. Remember, Wall Street brokers invented ETFs because Vanguard's no-commission index mutual funds were taking away business.
Indexing is no big deal
Despite all the hype, ETFs are no big deal. They're just another index fund. Except they trade all day like stocks (something passive investors don't do). The first ETF was launched in 1993. Today there's still only $225 billion invested in 151 ETFs, including $55 billion in one S&P 500 ETF.
Traditional index mutual funds are also no big deal. The first was launched in 1976 by Vanguard, an S&P 500 index fund. But three decades later there is still only $650 billion invested in all index mutual funds. And $350 billion are Vanguard's.
Compared with the total of $8.1 trillion Americans have invested in all 8,000 mutual funds, index funds are peanuts. The truth is, 92 percent of America's funds are actively managed and most make you pay commissions.
So why buy ETFs? There are two advantages. First, you can trade them any time during the day. Traditional mutual funds can only be traded once a day, at the close. But you pay a commission trading ETFs versus no fees for most index mutual funds. So ETF commissions are a waste of hard-earned money for passive investors.
Second: Experts will tell you an ETF's expense ratio is lower than a mutual fund's. Sorry folks, but that deal's a come-on, like a bogus new credit-card offer in the mail.
William Bernstein, a money manager, neurologist and author of "The Efficient Asset Allocator," used to think ETFs were interchangeable with mutual funds. Then he compared the two indexing giants; Barclays iShares ETFs versus Vanguard's index mutual funds.
His conclusion: "In all seven cases where a direct head-to-head comparison can be made, the Vanguard funds outperform the iShares [and] in some cases, it isn't even close." He says Barclays ETFs track their index exactly, but operating costs reduce returns and so the ETFs underperform the indexes. In contrast, Vanguard's index mutual funds don't track their indexes exactly. So, stock-picking flexibility helps Vanguard beat the indexes.
But you're buying ETFs anyway? Then here's the strategy: Buy and hold the ETFs, no active trading. Buy only ETFs that fit your lazy portfolio. And never even look at the other 140-plus ETFs available.
Let's illustrate with the "Coffeehouse Portfolio," one of our lazy portfolios. Bill Schultheis, a former Smith Barney broker and author of "The Coffeehouse Investor" launched it back in 1999. Ten-year average annual returns are 10.8 percent.
All-ETF winning lazy portfolio
There are only seven funds in the Coffeehouse Portfolio. The asset allocation is simple: Put 40 percent in a total bond index fund and 10 percent each in six equity funds. I asked the folks at Morningstar, Vanguard and Barclays for suggestions on substitute ETFs. So here's the portfolio with the seven Vanguard funds plus seven Barclay iShare ETFs as alternatives:
(40%) Bond Market Index (VBMFX]: news], chart], profile]) ; or iShares Lehman Aggregate (AGG]: news], chart], profile])
(10%) Standard & Poor's 500 (VFINX]: news], chart], profile]) ; or iShares S&P 500 (IVV]: news], chart], profile])
(10%) Large-Cap Value Index (VIVAX]: news], chart], profile]) ; or iShares S&P/BARRA Value (IVE]: news], chart], profile])
(10%) Small-Cap Index (NAESX]: news], chart], profile]) ; or iShares Morningstar Small Core (JKJ]: news], chart], profile])
(10%) Small-Cap Value Index (VISVX]: news], chart], profile]) ; or iShares Russell 2000Value (IWN]: news], chart], profile])
(10%) International Stock Index (VGTSX]: news], chart], profile]) ; or iShares MSCI EAFE (EFA]: news], chart], profile])
(10%) REIT Index (VGSIX]: news], chart], profile]) ; or iShares Dow Jones Real Estate (IYR]: news], chart], profile])
There are other ETFs tracking the same indexes. But there is little difference between brands. Moreover, most ETFs are new so there's little historical data.
Bottom line: Remember the curmudgeon's rules. If you're an average, passive Main Street Investor, the odds are your broker is making money while you're wasting it if you buy an ETF rather than a plain-vanilla no-load index mutual fund.
The perfect all-ETF portfolio But are ETFs really better than good old index mutual funds?
Paul B. Farrell], MarketWatch Last Update: 8:20 PM ET Feb. 6, 2005
ARROYO GRANDE, Calif. (MarketWatch) --Most of the time I'm a happy-go-lucky optimist. But when I see Joe and Jane Main Street getting conned again, something flips. Suddenly, I'm swallowing a curmudgeon pill, getting grouchier and grumpier than Andy Rooney.
A reader tells me exchange-traded funds are a better deal than index mutual funds in our "lazy" portfolios. Bah, humbug!
Lazy portfolios are diversified holdings of no-load index funds. They make money in bull markets and protect it in bear markets. They help passive investors who have full-time jobs and don't watch cable TV's talking heads guessing about markets and the economy.
The fact is that a very small percentage of America's 95 million investors are active traders. The rest would be wasting money by paying brokers' commissions to buy ETFs. No-fee mutual funds do a better job. So here are the crusty curmudgeon's three rules for ETFs:
If you're an average investor, never buy an ETF.
If you're a full-time active investor, buy ETFs. But remember you're helping your broker make payments on his BMW.
If you have an uncontrollable urge to buy ETFs, then I'll help you buy the right ETFs and build a winning lazy portfolio.
Are you really being conned? Yes. ETFs are great on paper because operating expenses appear lower. But, in practice, broker's commissions can kill returns. Remember, Wall Street brokers invented ETFs because Vanguard's no-commission index mutual funds were taking away business.
Indexing is no big deal
Despite all the hype, ETFs are no big deal. They're just another index fund. Except they trade all day like stocks (something passive investors don't do). The first ETF was launched in 1993. Today there's still only $225 billion invested in 151 ETFs, including $55 billion in one S&P 500 ETF.
Traditional index mutual funds are also no big deal. The first was launched in 1976 by Vanguard, an S&P 500 index fund. But three decades later there is still only $650 billion invested in all index mutual funds. And $350 billion are Vanguard's.
Compared with the total of $8.1 trillion Americans have invested in all 8,000 mutual funds, index funds are peanuts. The truth is, 92 percent of America's funds are actively managed and most make you pay commissions.
So why buy ETFs? There are two advantages. First, you can trade them any time during the day. Traditional mutual funds can only be traded once a day, at the close. But you pay a commission trading ETFs versus no fees for most index mutual funds. So ETF commissions are a waste of hard-earned money for passive investors.
Second: Experts will tell you an ETF's expense ratio is lower than a mutual fund's. Sorry folks, but that deal's a come-on, like a bogus new credit-card offer in the mail.
William Bernstein, a money manager, neurologist and author of "The Efficient Asset Allocator," used to think ETFs were interchangeable with mutual funds. Then he compared the two indexing giants; Barclays iShares ETFs versus Vanguard's index mutual funds.
His conclusion: "In all seven cases where a direct head-to-head comparison can be made, the Vanguard funds outperform the iShares [and] in some cases, it isn't even close." He says Barclays ETFs track their index exactly, but operating costs reduce returns and so the ETFs underperform the indexes. In contrast, Vanguard's index mutual funds don't track their indexes exactly. So, stock-picking flexibility helps Vanguard beat the indexes.
But you're buying ETFs anyway? Then here's the strategy: Buy and hold the ETFs, no active trading. Buy only ETFs that fit your lazy portfolio. And never even look at the other 140-plus ETFs available.
Let's illustrate with the "Coffeehouse Portfolio," one of our lazy portfolios. Bill Schultheis, a former Smith Barney broker and author of "The Coffeehouse Investor" launched it back in 1999. Ten-year average annual returns are 10.8 percent.
All-ETF winning lazy portfolio
There are only seven funds in the Coffeehouse Portfolio. The asset allocation is simple: Put 40 percent in a total bond index fund and 10 percent each in six equity funds. I asked the folks at Morningstar, Vanguard and Barclays for suggestions on substitute ETFs. So here's the portfolio with the seven Vanguard funds plus seven Barclay iShare ETFs as alternatives:
(40%) Bond Market Index (VBMFX]: news], chart], profile]) ; or iShares Lehman Aggregate (AGG]: news], chart], profile])
(10%) Standard & Poor's 500 (VFINX]: news], chart], profile]) ; or iShares S&P 500 (IVV]: news], chart], profile])
(10%) Large-Cap Value Index (VIVAX]: news], chart], profile]) ; or iShares S&P/BARRA Value (IVE]: news], chart], profile])
(10%) Small-Cap Index (NAESX]: news], chart], profile]) ; or iShares Morningstar Small Core (JKJ]: news], chart], profile])
(10%) Small-Cap Value Index (VISVX]: news], chart], profile]) ; or iShares Russell 2000Value (IWN]: news], chart], profile])
(10%) International Stock Index (VGTSX]: news], chart], profile]) ; or iShares MSCI EAFE (EFA]: news], chart], profile])
(10%) REIT Index (VGSIX]: news], chart], profile]) ; or iShares Dow Jones Real Estate (IYR]: news], chart], profile])
There are other ETFs tracking the same indexes. But there is little difference between brands. Moreover, most ETFs are new so there's little historical data.
Bottom line: Remember the curmudgeon's rules. If you're an average, passive Main Street Investor, the odds are your broker is making money while you're wasting it if you buy an ETF rather than a plain-vanilla no-load index mutual fund.
