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The August 2018 AAII Journal is Now Available Online

Feature Article:

The Individual Investor’s Guide to Exchange-Traded Funds 2018

Our expanded guide covers 542 exchange-traded funds, providing detailed return information and data as well as an update on the ETF industry.

 

 

 


Portfolio Strategies »

Observations From Decades of Tracking Investment Newsletters

There is often little persistence in outperformance among newsletters, but the good long-term performers have shown consistency in sticking to their strategies.


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Current news items of interest to individual investors.

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Comments on bucket portfolios, REIT resources and adding new selections to the Model Shadow Stock Portfolio.


Editor’s Note »

I’m happy to give you an update on the ongoing price war among brokerage firms and within the exchange-traded fund (ETF) industry.

This month, Vanguard will be waiving commissions on nearly 1,800 ETFs. Not just Vanguard ETFs, but ETFs offered by other fund sponsors. For smaller investors, it instantly boosts after-cost returns. For large investors, it keeps more money in your account. Just like the loose change thrown into a coin jar, small amounts add up over time.

The move could put pressure on other discount brokers to follow suit. While the likes of Charles Schwab, Fidelity and TD Ameritrade waive commissions on certain ETFs, the size of their commission-free list is much smaller than Vanguard’s will be. How long this will stay the case remains to be seen. What is and isn’t commission-free currently depends on negotiations between ETF sponsors and the brokers. Vanguard has refused to pay to be on broker commission-free lists, according to The Wall Street Journal. This month’s change could have the potential to shake things up.

Fund fees are also continuing to fall. State Street cut fees last year and BlackRock further reduced fees on some of its iShares ETFs a few months ago. This matters because fund fees are continuously charged, whereas commissions only get billed when you transact.

While downward pricing pressure is often a deterrent to competition, that has yet to be the case among ETFs. During a presentation I gave to a small group of investors in July, I displayed a chart showing the year-by-year growth in our annual ETF guide. Our first guide, published in 2003, covered approximately 130 funds. The online version of this year’s guide covers 2,162 funds.

The trend of ongoing growth could continue. In late June, the U.S. Securities and Exchange Commission (SEC) proposed a new rule governing the approval of new ETF applications. Currently, companies wishing to launch an exchange-traded fund must seek an exemption from the Investment Company Act of 1940 (aka the ’40 Act). It’s a time-consuming and costly process. The proposed change would allow ETFs that satisfy certain conditions to come to market without applying for exemptive orders. The commission is currently seeking comments on the proposal.

More options—especially more lower-cost options—are a good thing, but there are trade-offs. The waiving of commissions removes a psychological (and financial) barrier to trading less frequently. Having a larger number of ETFs to choose from complicates the decision process. An oft-cited study on choice found that consumers were more likely to make a purchase decision when six jams were offered instead of 24. Choosing from the 2,162 ETFs that are currently available can be downright daunting.

An easy way to simplify the process is to focus on just your investing needs. If you need exposure to stocks, buy a plain-vanilla S&P 500 index fund. If you need bonds, buy a plain-vanilla bond fund. A rule of thumb for identifying such funds is to look at the largest ETFs for a broad category (e.g., large-cap stock or intermediate-term general bond). Be sure to read the prospectus to see if the ETF invests in what you want it to.

Alternatively, you can choose to follow a model portfolio. Our Level3 Passive Portfolio was discussed in the June 2018 AAII Journal article “Guidance on How to Follow the Level3 Passive Portfolio” by John Bajkowski. Our founder, James Cloonan, chose ETFs for this model portfolio that have characteristics he believes will lead to long-term outperformance.

For those who want a more hands-on approach, start with your allocation and determine which categories of funds fit your portfolio needs. Then compare and contrast, paying attention not only to recent returns, but also to how an ETF has historically performed relative to its peers and how the expense ratios and tax efficiency stack up. For newer funds, the inability to compare historical returns is a risk. In all cases, look at the underlying index tracked, review the fund fact sheet and read the prospectus. ETFs with similar sounding names can have different portfolios and different returns. Do your homework and never assume a particular ETF is preferable just because it is commission-free.

Wishing you prosperity,

c

Charles Rotblut, CFA
Editor, AAII Journal
@CharlesRAAII

 

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