To riff on the proverb that the best things in life are free, in an investor’s life, they may well be commission-free — at least when it comes to exchange-traded funds, or ETFs.
ETFs have experienced “spectacular global growth,” according to Ernst & Young’s 2014 Global ETF Survey, which interviewed more than 60 promoters, securities dealers, investors and service providers in 21 cities and 13 markets. It was published in January, with information compiled in October and November 2013. The company forecasts “annual growth rates of 15 percent to 30 percent around the globe in the coming five years” and anticipates that the ETF industry will surpass hedge fund assets under management in the next 12 to 18 months.
Regardless of whether that happens, the domestic numbers prove staggering. Ernst & Young projects ETF assets in the U.S. will expand by more than 15 percent annually. Those assets totaled about $1.88 trillion as of October, the Investment Company Institute reports, up from $1.61 trillion in October 2013.
Commission-free ETFs at companies such as Charles Schwab and Vanguard are obvious drivers of the expansion. In terms of improving one’s investment prospects, “There are no specific advantages other than there is no cost to trade, so these are definitely more beneficial for smaller-sized accounts,” says JJ Feldman, investment manager for Los Angeles-based Miracle Mile Advisors, an independent investment advisory firm.
In a Nov. 25 post on LinkedIn, “Three ETFs I’m thankful for,” Feldman singled out funds that have performed exceptionally well during the stock market’s bull run. Miracle Mile Advisors’ top performer was Vanguard REIT ETF (the fund is offered commission-free through Vanguard). “After a disappointing 2013, real estate investment trusts have surged in 2014,” Feldman writes, with the ETF up more than 25 percent through the end of November.
Yet, as much as Feldman loves his ETFs, he says investors have to be careful not to go overboard. “Having no trading cost also might cause investors to trade them more frequently,” he says. “That potentially could be a bad thing, as market timing is virtually impossible.”
In essence, ETFs contain investments such as stocks, bonds or commodities, and they generally track an index, such as the Standard & Poor’s 500 index. Unlike mutual funds, ETFs trade like stocks and experience price changes throughout the day as they are bought and sold.
“Most ETFs aren’t meant to beat a market’s performance,” says Dan Greenshields, president of Seattle-based Capital One ShareBuilder and president and chief investment officer of ShareBuilder Advisors LLC. As a result, “self-directed investors can often access broad market indexes for very low costs compared to many mutual funds.”
Therefore, if a given index performs well, so does the ETF. Although the lack of commission may prove a bonus, “the fact that the ETFs are free isn’t that critical,” Feldman says. “Some ETFs are market-cap weighted, fundamentally weighted or dividend-weighted. The most important thing is to identify the ETFs that you like based on their strategy and risk-return profile.”
And although they’re often marketed as commission-free, in many cases, ETFs carry some fees, small as they are. Investors lured by the “free” part may select a fund based on upfront costs as opposed to its superior value potential.
“The limited number of firms offering commission-free trading on a few ETFs may have higher fees on services,” says Vern Sumnicht, founder and CEO of iSectors, an ETF investment strategist based in Appleton, Wisconsin. “That would cause me to carefully consider whether the commission-free trading on ETFs is enough of an advantage for me to select them for custody and trading of my or my clients’ portfolios.”
“It is important to read the fine print,” says Paul Jacobs, chief investment officer of Palisades Hudson Financial Group and based in the firm’s Atlanta office. “Fidelity charges a short-term trading fee of $7.95 for sales within 30 days. We don’t trade frequently, so this isn’t a deterrent for us,” he says.
There are other concerns Jacobs lists as crucial. “We’ve learned not to just focus on average trading volume, but instead to look at the actual volume for each day of the last few months,” he says. “Some ETFs have very lumpy trading, and while they have a high average volume, they see little or no shares trade hands most days. So if we’re looking to do a medium or large-size trade, it’s important we understand what trading volume is like each day, not just on average.” The takeaway for the average retail investor? Work with a financial advisor who recognizes a robust ETF for its steady, day-to-day performance.
Another caution experts pass on is to avoid attaching ETFs to a robo-investing platform that’s totally automated. “A hybrid human-robo approach works well when it comes to investing,” says Asheesh Advani, CEO of Covestor, an online investing marketplace with offices in Boston and London. “Investors can establish broad exposure to the market with core ETF portfolios and pay no management fees. Then, they can use actively managed portfolios where they take more risk in search of higher returns. This combination can lower overall volatility and give investors a better chance to outperform the market,” he says.
No matter how investors choose to approach the ETF market, it’s advisable to keep another retooled cliché in mind. Fee-free is one thing, but when it comes to a creating a viable, valuable portfolio with ETFs, there’s no such thing as a free lunch.
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How to Take Advantage of Fee-Free ETFs originally appeared on usnews.com
