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Rant about ETFs

July 2nd, 2010 at 07:31 am

Not a very interesting topic, but I just want to get this off my chest.

For years now, I still see online that people tout ETFs because of their low expense ratios relative to their equivalent mutual funds. Based on that, they therefore conclude that ETFs are better.

However, with a few exceptions, ETFs also require a trading fee. Translated into mutual fund terms, that's a front and a back load you have to pay as well!

Now, I'm not saying that in certain circumstances, ETFs can't be cheaper. I'm saying the real answer is: It Depends.

* It depends on how much you contribute. The smaller your contribution balance is, the larger in percentage your trading fees are.

* It depends on how often you contribute. If you're in a 401(k) program, where you may be automatically contributing bi-weekly, the fees are going to destroy you. However, if you're someone who is only making annual buys, say, in an IRA, then it's not so bad.

* It also depends on how many ETFs you plan on buying. A typical portfolio will consist of at least one large cap ETF, one bond ETF, and perhaps an international ETF. You may have more, and the point is, all those ETFs each require a separate trading fee from you.

* And finally, it depends on your existing balance. For example, if you're someone who is just starting out and have a fairly small amount, the difference in the expense ratio is negligible. Now, if you have a lot of money already invested, then yes, I agree expense ratios are extremely important.

Bottom line, I don't understand what the fascination with ETFs are. I mean I can articulate circumstances where even I will use them, but for the most part, I think you can do just fine with regular mutual funds.

Investing isn't always exciting, but it doesn't have to be. It just has to work.

4 Responses to “Rant about ETFs”

  1. disneysteve Says:

    I have always agreed, but times are changing. Both Vanguard and Schwab, to name two biggies, now sell ETFs commission-free. That makes them much more attractive even for small investors or those who invest over time. I have not switched into ETFs myself but I've been thinking about it since we have a lot of money with Vanguard. It would be a simple matter to convert from some of our index funds to comparable ETFs.

  2. Broken Arrow Says:

    Yes indeed! Well, the Vanguard one is news to me, but I've known about the Fidelity deal for a little while now. They offer basic Powershare ETFs commission-free, and there's about a dozen of them. Good enough to build a basic portfolio, but more specialized ETFs still cost money.

    That and I don't know how prevalent or how permanent this deal is? There is a good possibility that Vanguard and Fidelity are currently engaged in a price war, hence the freebie deal.

    Moreover, on a strict expense ratio basis, select index funds such as Vanguard's Admiral Shares and Fidelity Spartan Funds can be just as competitive, each floating around 0.1%.

    Either way, my only point of contention is that I don't believe in blanket statements such as "ETFs are always better than mutual funds" or vice versa. It just depends.

  3. disneysteve Says:

    "Either way, my only point of contention is that I don't believe in blanket statements such as "ETFs are always better than mutual funds" or vice versa. It just depends."

    For sure. Until I heard about the Vanguard and Schwab deals, I didn't really see much point at all in ETFs since I'm a dollar-cost-averaging investor. It is only now that they've eliminated the commissions that I've started to take a closer look.

  4. Broken Arrow Says:

    Oops! I meant Schwab, not Vanguard. But in any case, Schwab only has eight ETFs that are listed for the free commission, and their expense ratios range from 0.06% to 0.35%. That's still comparable to the index fund examples I've listed earlier, which is really 0.07% to 0.09%.

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