Why I Like ETFs And You May Too
What would you prefer: pay a little and get more or pay a lot and get less? I’d prefer the former and this is the conclusion that I have reached from reading about ETFs. You are getting more (in investment returns) and for much less (in management fees).
An ETF and is a fund that invests in many of the companies in a stock market index like for example the S&P 500. I’ve been slowly moving towards ETFs because of the automatic diversification as well as low fees and the fact that they do just as well or maybe even better in some cases than managed mutual funds.
Simple Fund Comparison
Take the Vanguard S&P 500 ETF (VOO) compared with the MorningStar identified one fund: Putnam Capital Spectrum – PVSYX (Large Blend) mutual fund with a high 1.02% expense ratio.
Of course, VOO is an index fund and PVSYX is a mutual fund managed by the Putnam advisors. Both funds are primarily invested in US stocks and don’t see much difference in terms of return (see chart below). Actually, VOO seems to be doing a little bit better than PVSYX maybe around 3%.
Fee Comparison
So if we continue with the example of the above two funds, if then scenarios for fees are like this:
If you invest $10,000 in PVSYX, your fee will be ($10,000 X 1.01%) = $101 per year
If you invest $10,000 in VOO, your fee will be ($10,000 X .05%) = $5 per year, that’s a BIG difference.
Motley Fool believes that low fees mean more money dividend income in your pocket and this is an important factor when evaluating ETFs. Heck, even Warren Buffet agrees that fund managers are charging too much as the “eat up capital like crazy.” He didn’t become a billionaire by paying outrageous fees. 🙂
So Why Do People Pay So Much For Fund Management?
Well, some people are more comfortable just knowing their money is being managed by an actually qualified professional who went to a fancy business school has got a certification or two under their belt.
Actually, to be honest some fund managers are very popular as they’ve earned a lot of respect in the financial services world for the performance of their funds. For example, Bill Miller who used to work as a fund manager for Legg Mason, Inc. beat the S&P 500 index 15 years in a row with his Legg Mason Value Trust Fund. He’s made some bad bets after that like investing in Fannie Mae and Freddie Mac during the meltdown of 2008. That really didn’t work out well.
Some people think they don’t know enough about the market to invest wisely. And others are skeptical because ETF is relatively new as compared to traditional mutual funds.
ETFs Gaining More Traction
Regardless of the reason as per the book 10 Golden Money Tips by Financial Advisor Jacob Nayman, he states that although “mutual funds have been a popular way to invest for several decades, whereas ETFs are relatively new, their popularity is based on lower cost, better tax treatment, and returns as compared to mutual funds.”
Furthermore, to get your foot in the door of ETFs, there is no minimum; just find an online broker that to facilitate the buying and selling. I use Robinhood….because it’s Free!!! Robinhood is a trading app for your smartphone that is pretty simple to use, does not really have any bells and whistles and because of this, you are able to trade for free.
In sticking with the same fund above: VOO, it’s available to trade on the Robinhood app. I used this as an example because it tracks the investment performance of the entire S&P 500 Index. Are you still nervous about investing in ETFs? Check out this video that explains how ETFs work in a very easy way. It discusses how to buy, what they invest in, how to earn money and what the risks are:
Unlike many mutual and even some index funds out there which may require an investment of $500, $1,000 or even more, ETFs require no minimums to invest.
Please bear in mind that I’m not against index funds at all. They offer a lot of diversity just like ETFs, mimic indexes and have proven to have performed better than many mutual funds out there.
However, if you are new to investing and want to test out the waters a little bit, an ETF would be more advantageous because of the simple fact that you “can invest in an ETF by buying as little as one share, making the initial minimum for ETFs generally lower than minimums for index funds.” The article does mention fees for ETFs in terms of a commission because ETF dividends don’t automatically reinvest like that of an index fund. For me, it’s not a bother that the dividends for my ETFs are going into my cash account with Robinhood because trades are free! Plus it gives me an opportunity to see if I want to use the dividend to buy more shares of the same ETF of something different, not to mention I prefer to be semi-passive with my investments anyway.
Anyway, I don’t want to go on and compare the benefits and drawbacks of ETFs vs index funds. For me, they are almost the same and you really can’t go wrong with either type.
I’ll leave you with three fund options for which I am contemplating a purchase.
- VOO – Vanguard 500 Index Fund
- IVV – iShares S&P 500 Index (ETF)
- SWPPX – Schwab® S&P 500 Index Fund
Note: This article originally appeared at Simple Money Man on April 2, 2018.
Category: ETFs
