Let’s assume Madam Marie, your local crystal ball-gazing psychic, decided to set up shop on Wall Street. Laugh if you like, but she might pick ’em just as well with tarot cards as investment gurus do with charts. After all, predicting the future in investment is risky business. Just ask Jim Cramer, whose Mad Money went bad, bad, bad after he went extra-bullish on Bear Stearns hours before it made a spectacular swan dive.
But it’s easy to imagine even the good madam choking on her pickled beets when in 2014, EY made an incredible prediction. In a survey of exchange-traded funds, they noted that the category had experienced “spectacular global growth.” And so, they put their money where the gaping mouths were: ETFs, they prophesied, would hit “annual growth rates of 15 to 30 percent around the globe in the coming five years.”
Really? Come on.
[See: 9 ETFs for Nervous Investors.]
But it turns out EY was right — in fact, more than right. And if ETFs were rock stars, they’d rank right up there with Bruce Springsteen and U2. Worth a total of $2.3 trillion in 2014, total global ETF assets have nearly doubled in three years, to $4.4 trillion as of September.
The industry “continues to defy superlatives,” EY says in its 2017 global ETF report. To put things in perspective, $4.4 trillion is more than the gross domestic product of Germany, the world’s fourth largest economy.
Closer to home, “ETF’s are wildly popular because they are cheap and easy — and Americans love that combination,” says Ryan Krueger of Krueger & Catalano Capital Partners in Houston. Cheap and easy, he notes, is now knit into our investor/consumer DNA. “More people have signed up to be Amazon Prime members than voted in the last U.S. election.”
So what are ETFs? In essence, ETFs are securities that track a commodity, asset group (such as an index fund) or a given index (such as the Standard & Poor’s 500). Unlike a mutual fund, its net asset value isn’t calculated every day. Instead, it trades like a stock on an exchange and goes through price changes as ETFs get bought and sold. So if a given index or commodity does well, so does the ETF.
Commission-free ETFs at companies such as Charles Schwab Corp. (ticker: SCHW) and Vanguard are obvious drivers of the expansion, as the fee-free structure of many ETFs makes for many a breathless investor. Meanwhile, “Vanguard is inhaling about a billion dollars a day,” Krueger says.
“Investors want to access global capital markets efficiently — that is to say at low cost — with ample liquidity and minimal tax consequences,” says Brian Sterz, portfolio manager at Miracle Mile Advisors in Los Angeles. “ETFs are an effective way to access an array of investment markets, from U.S. equities to emerging markets debt and everything in between, without paying an added layer of management expenses — which may or may not add to performance.”
In fact, at least one Nobel Prize-winning economist maintains that cost-free investments (a category ETFs fall into) compare favorably to using a financial advisor, whose gains over time can be offset by fees and wrong bets.
[See: 7 Investment Fees You Might Not Realize You’re Paying.]
On a recent episode of the public radio show “Freakanomics,” University of Chicago professor Eugene Fama says, “When you look at the world after costs — which is what people eat … well then the whole [investment] industry looks pretty bad.”
Venturing a step further, is there any point in concluding that ETFs offer a better way to beat the market than most investment strategies?
“Absolutely none whatsoever,” says Robert Johnson, president and CEO of the American College of Financial Services in the Philadelphia area. “In fact, I’d contend that the way ETFs are utilized — that is, traded throughout the entire day — leads to them underperforming the market.”
Even smart beta ETFs, which mix active and passive investment methods, can’t claim be-all-and-end-all status.
“If the market were to fall a great deal, one of the drawbacks of low-cost beta ETFs would be that they would go down as much as the market,” says Sean O’Hara, president of Pacer ETFs in Paoli, Pennsylvania. “If you wanted to beat the market during a downturn, then you’d need to own an ETF that would move its exposure away from equities during one of these periods.”
And so it turns out — and so often turns out in the investment milieu — that the truth lies in balance: landing somewhere between no-fee frenzy and appropriate exposure.
“Low fees can matter a lot,” says Dave Nadig, managing director of ETF.com.
He cites a standard model published by the Securities and Exchange Commission that demonstrates how, over 20 years, a 25 basis point difference in fees adds up to a $10,000 difference on a $100,000 portfolio.
“The impact is huge over the long term,” Nadig says. “Does that mean you need to move your portfolio into the cheapest ETF, always? No, of course not, because exposure matters, too. But if you’re comparing apples to apples, lower cost always wins.”
[Read: What Is an ETF? The Ultimate Guide.]
Not even Madam Marie can read the tea leaves like that.
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Are ETFs Best for Investing? originally appeared on usnews.com
