Essay on An Overview of ETFs

Essay on An Overview of ETFs

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Mutual funds were long considered one of the best available easy-to-invest instruments that minimized risk and maximized returns. In the 80’s and 90’s, the US financial markets made trillions of dollars with the mutual fund structure. The funds, especially the most actively managed ones, were expected to outperform the market index in the long run. However, with expense ratios ranging as high as 1.5% to 2.5%, the funds underperformed the index by the amount of their expense ratio.

What is an expense ratio and how does it reduce performance? Investors use expense ratio as a major metric to decide on investment products. Expense ratio in a mutual fund is comprised of the investment management fee, a 12b-1 fee, also known as the cost of distribution, and other operating expenses. A shareholder pays the fee on a daily basis through an automatic reduction in the price of a fund. If you invested in an exotic mutual fund with an expense ratio of 2.5%, after 30 years, you would have only $87,550 and paid a whooping $86,944 (almost 50%) in expense fee. Let’s look at another example. If you invested in a fund with an expense ratio of 0.5% (typical for index funds), after 30 years you would have $152,203 and paid a total of $22,291 (or 12.8%) in expenses. So high expense ratios can really hurt your investment performance.

Exchange traded funds or ETFs, as they are known, far eclipse mutual funds for their biggest benefit amongst others, the low expense ratios. Expense ratio for a mutual fund goes beyond 1.5%, while for an index fund is 0.19%, but a typical ETF expense ratio is only as low as 0.13%. What that means is you could simply buy the index with a low-cost ETF and outperform almost all mutual funds over the long term by at le...

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...short of spectacular. Invented in 1993, they started with one domestic fund and have since growth to more than 1100 ETFs that track domestic and global indexes, sectors, even alternative investments like water, timber, clean energy and solar. And there are more coming online everyday. The new funds offer long exposure in areas like China, Emerging Markets, the Wilshire Total Market Index and leveraged short exposure in the Russell 3000, DJ Wilshire Total Market and a host of country specific funds like Brazil, Mexico, South Korea and region specific like Latin America, Europe and the Pacific.

Given the flexibility, diverse options, tax and expense advantages, ETFs present an attractive option that every investor should consider for his portfolio, particularly in these difficult times and when 401ks are IRAs are more important than ever to our financial futures.

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