Five Reasons to Consider Investing in ETFs Instead of Mutual Funds

Exchange traded funds, or ETFs, have grown almost ten-fold over the past decade, from a $228 billion market in 2004 to nearly $2 trillion at the end of 2014. Nevertheless, their popularity among investors still trails that of mutual funds. According to the Investment Company Institute, 46% of U.S. households own mutual funds and only 4% own ETFs.

There are many possible reasons for that. ETFs are still a fairly new investment vehicle. Mutual funds have been around since the 1920s, while ETFs came onto the scene in 1993. Mutual funds are the main investment vehicle available in 401(k)s, while ETFs can only be bought in brokerage accounts or IRAs. Not least, says Brad Jenkins, chief executive and chief investment Strategist at Jenkins Wealth, investment brokers have little incentive to sell ETFs, because they don’t earn a commission on those sales, while they do on many actively-managed mutual funds.

For the needs of many everyday investors, however, ETFs offer notable advantages over mutual funds.
 

Lower costs

“ETFs generally have a lower cost structure and for retail investors, they can be a much more economical vehicle than mutual funds,” says Wayne Schmidt, chief investment officer at Gradient Investments. “Anything they can do to limit the cost behind the product is important to retail investors.”

According to SigFig data, investors paid on average 62 basis points for mutual funds in the 12-month period ending March 8, 2015, and an average of 17 basis points for ETFs. Actively-managed mutual funds are even more expensive, and average 125 basis points in expense ratio, according to fund research firm Morningstar.
 

Performance

As the New York Times wrote recently, research on whether it is possible to beat the stock market over time typically comes to conclusions ranging from “no” to “most probably not.”

We do know that cheaper investments outperform expensive ones, even during a bear market — and actively managed funds (the ones trying to beat the market) tend to be more expensive than passive index funds. The Economist recently put the odds of a large cap mutual funds beating the market over the past 20 years at 25%:

“But the index doesn’t have costs and the fund managers do. Those costs doom the fund managers to underperform. One does not have to believe in the efficient market hypothesis to understand this outcome. But to the extent that any market is efficient, large-cap US stocks is the one; dozens of analysts cover every stock and their business models are well known and understood. The chance that any investor has a unique insight into a particular company is very small.”

 

Tax advantages

When a mutual fund manager buys and sells throughout the year, they can trigger tax events, of which fund investors have no control (and often, no knowledge). The higher a mutual fund’s turnover, the more its manager is trading in and out of positions. If they sell certain stocks at a gain, that tax hit passes onto the fund investors in the form of lower returns.

ETFs, meanwhile, have much lower turnover, says Jenkins. “ETFs don’t have human beings doing a lot of buying and selling,” he says. “An ETF may get rid of one stock in the course of a two-year period.”
 

Liquidity

Another benefit of owning an ETF over a mutual fund is the ease of trading. Trading in a mutual fund requires placing your order during market hours and waiting until the following day for the transaction to be completed. With an ETF, you can get in and out during market hours. “If someone wants to buy an ETF at a specific price, they get that within a couple of pennies,” Jenkins says.

This might be of little importance to buy-and-hold investors, and might not matter much even to more frequent traders in a non-volatile market environment. When the market starts moving multiple percentage points during a single day, however, waiting a day to actually or sell an investment may mean a sizeable difference in how much you get when you sell, or how many shares of a fund you buy.
 

Diversification

At the end of 2014, there were 1,411 ETFs spanning all major asset classes, so that building a diversified ETF portfolio is entirely possible. “ETFs span a lot of different asset allocations and lots of parts of the world,” says Andrew Brownsword, senior vice president at Fidelity retail brokerage. All those asset and geographic allocations combined give investors a lot of flexibility.

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Image: Investment Company Institute.

Donna Fuscaldo is a freelance writer based on Long Island, NY. Her work appears on Foxbusiness.com, Bankrate.com and Glassdoor.com.

Understanding and Minimizing Fund Fees

Do you know how much you’re paying for your investments? Fund fees are a necessary evil — one that investors cannot avoid altogether, but should do their best to minimize and understand. The industry has a poor track record of transparency in this regard.

The two major types of fund fees you need to evaluate when reviewing your investment options are expense ratios and commissions. Here is what you need to know about each:

1. Fund expense ratios

The most common fee investors hear about is the expense ratio, which typically includes all the costs associated with running the fund, including administration and back office functions.  Fees covering distribution and shareholder service expenses, known as 12b-1 fees, are also typically included in the expense ratio.

The simplest way to think of an expense ratio is what the fund charges annually per dollar of investment. Fund returns are stated net of this fee.

Expense ratios vary by an order of magnitude across funds. Passive index funds tend to be lower cost, while actively-managed funds charge significantly more.  According to Morningstar, the average actively managed fund charged 1.25% in fees in 2013, compared to 0.44% for the average ETF. Across SigFig users, State Street’s SPDR S&P 500 Trust (SPY) is the most popular index ETF, and charges 0.09%. Vanguard’s Total Stock Market Index (VTI) charges 0.05% — that’s 25 times less than the average actively managed fund.

Expensive funds could be worthwhile if they delivered better returns, but research has shown that high-cost funds underperform low-cost ones over time (even during bear markets), and that fund performance is negatively correlated with cost. Simply put, the lower the fees, the greater the investor’s net returns.

Analyzing fund returns for the 12 months ending March 8, 2015, SigFig found that funds with a 0.25% expense ratio earned nearly double the returns of those with a 1% expense ratio: 9% vs 4.8%.

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The New York Times recently summarized research finding that in the past six years no actively managed fund has ever consistently beaten the market:

The truth is that very few professional investors have actually managed to outperform the rising market consistently over those years… In fact, based on the updated findings and definitions of a particular study, it appears that no mutual fund managers have…

And even if a small minority of fund managers do, it is very difficult to identify who they are in advance.
Takeaway:
Buy low-cost index funds. Avoid high-cost actively managed funds, even those that have performed well in the past. (How low is low? ETFs that passively track the major indices typically charge 0.15% or less.)

2. Fund commissions, or loads

Mutual fund companies are in the business of making money. They want investors to buy their funds and, to that end, some funds pay broker dealers a commission for hawking the product.  A front-end load is a fee, typically up to 5% of invested assets, charged upfront. A back-end load is charged when you sell the fund and tends to get lower with each year you hold the fund. A no-load fund, on the other hand, has no commission associated with buying or selling.

How do you know what type of fund you are investing in? Brad Jenkins, chief executive and chief investment Strategist at Jenkins Wealth, says to look at the letters in the fund’s name. If it includes mention of Class A, B, or C, you are paying a commission.
Takeaway:
Don’t invest in load funds altogether. Instead, go with a no-load fund, or buy an ETF.

Donna Fuscaldo is a freelance writer based on Long Island, NY. Her work appears on Foxbusiness.com, Bankrate.com and Glassdoor.com.

Four Tax Efficient Strategies for Everyday Investors

Death and taxes may be the only certain things in life, yet investors often don’t give as much thought as they should to the tax implications of their actions.

“People think about taxes last,” says John Piershale, founder of Piershale Financial Group. “But they have to stop and realize every transaction has a tax consequence.”

Taxes alone shouldn’t drive your investment strategy, but that doesn’t mean they should come last. Here are four tips that might reduce the tax bill on your investment income.
 

1. Don’t think of tax loss harvesting as a fourth-quarter thing.

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Investors who generate capital gains taxes often engage in tax loss harvesting. This means they will sell a holding at a loss to offset the gains generated by the sale of another holding. This can often be a wise strategy, but one should not wait until the fourth quarter to pursue it, says Peter Mallouk, president and chief investment officer at Creative Planning. “Investors should be looking throughout the year for the opportunity to offset losses,” he says. “It should be part of the ongoing management of the tax implications of their portfolio.”
 

2. Hold dividend- and interest-paying investments in tax-deferred accounts

Bonds and bond funds can diversify a portfolio while providing some yield. However, if those fixed-income investments are held in a taxable account, the interest earned is taxed as ordinary income. “If you have a corporate bond paying 4%, you are not making 4%,” says David Richmond, founder of Richmond Brothers. “You are making 4% minus whatever fee you had to pay to buy the bond [and] the tax hit.”

The same goes for bond fund dividend distributions, which are also taxed at the typically higher, regular income tax rate. By comparison, dividends from individual equities and equity funds may be taxed at the lower qualified dividend tax rate. In either case, investors may benefit from keeping dividend-paying investments out of taxable accounts and instead holding them in retirement accounts, like an IRA or 401(k). This allows investors with ordinary income to avoid increasing their tax liability.

While holding high dividend- or interest-yielding securities in taxable accounts is not efficient for tax purposes, however, investors shouldn’t necessarily rush to sell their positions, says Richmond, adding that sound investment strategy requires more than simple tax efficiency. “If I wanted to make an allocation change, then I would do so over time, as the asset pricing dictates a change,” he says.

If you are considering moving interest- or dividend-earning investments from taxable to tax-deferred vehicles, such as an IRA or a Roth IRA, factors to consider include capital gains taxes, wash sale rule navigation, and your eligibility to contribute.
 

3. Don’t exercise gains on an investment, only to replace it with a similar one.

According to Mallouk, often investors sell a stock, ETF or mutual fund after it has had a nice run, take their profits, and buy another stock in the same asset class — and come tax time, pay the (tax) consequences.

“If you have an energy stock up 10%, sell it then buy another energy stock you like more, the odds are good you paid taxes to buy something else that is highly correlated to what you just sold,” Mallouk says. “In other words, you are in generally the same place — but have paid taxes.“

Mallouk argues that a better option when you have an outperforming stock is to take the gains and put your money in a different sector or asset class.
 

4. Pay attention to the turnover rate of mutual funds

Many investors allocate their non-retirement assets to mutual funds to stay diversified. What they may not realize is the turnover rates of those funds might impact how much they are going to pay Uncle Sam. “The turnover rate — or how much buying and selling the [fund manager] is doing — gets distributed to you in capital gains or losses,” says Richmond. “If the fund turned over the holdings once in the last 12 months, whatever the profit was, minus any losses, gets passed through to investors.”

Because of the tax implications, keep an eye on the turnover rate when choosing your mutual fund, Richmond says. Better yet, consider investing in passive index funds or ETFs, which have lower turnover ratios, and are often more tax-efficient as a result.
 

Taxes are undoubtedly a major part of any sound investment strategy, but at the end of the day, they can’t be the driving factor, either. When it doubt, most investors might be better off un-complicating things by investing in passive, low-cost ETFs.

This information was prepared to explain general tax-efficient strategy. Prospective investors should confer with their personal tax advisers. SigFig assumes no responsibility for the tax consequences to any investor of any transaction.

SigFig first published this article on DailyFinance.com. To read more stories we have contributed to Daily Finance, click here.

Donna Fuscaldo is a freelance writer based on Long Island, NY. Her work appears on Foxbusiness.com, Bankrate.com and Glassdoor.com.

Men, Women Invest Differently. Here’s How They Can Benefit From Working Together

Men are from Mars, women are from Venus. The book title-turned cliché phrase happens to be as true of relationships as it is of investing. Men and women behave very differently as investors, be it when it comes to which stocks they pick or the type of brokerage firms they trust to manage their money.

“Men are looking to hit their investment selections over the fence,” says Stan Corey, managing director at United Capital. “Women are willing to hit singles and doubles.”

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Women tend to be more conservative in the investments they choose. That’s particularly true of women who have recently become single, whether through a divorce or because they are widowed, says Kimberly Foss, president and founder of Empyrion Wealth Management. Even married women are making safer bets with their investment dollars than their male counterparts.

“In many cases, [making safer bets] is the right choice,” she says.  “Women are still three times more likely than men to leave the workforce to care for children. And being away from the workforce means no 401(k) account and no company matches or pensions. Therefore, with less dollars to invest, it’s natural to be inclined to protect those dollars.”

How women choose their financial advisor or brokerage firm also differs from men. According to research from San Francisco-based investment firm SigFig, men tend to be more likely to choose a brokerage or investment firm that ends in “trade” (E*Trade or Scottrade), while women gravitate towards firms like Schwab and Vanguard.

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Audra Lalley, a financial advisor at Miracle Mile Advisors, says female investors want to feel a level of trust with their advisor upfront, while men are more likely to jump right into the investing process and decide as they go along how much clout their investment professional will carry.

And when it comes to the investment vehicles they pick, women are much more inclined to stick to investment vehicles they know and stay away from things they can’t understand, be they structured notes or collateralized mortgage obligations, says Lalley. “Men tend to gravitate toward riskier products, whether or not they can reverse-engineer them themselves,” she says.

Women also tend to be long-term investors, which means they pick a stock or investment idea and stay with it over the long haul. That could be one of the reasons their portfolios did 12% better than men’s portfolios in 2014. Thanks to this buy-and-hold attitude, women may be less likely to panic over daily market gyrations and end up selling low and buying high.

One area where women trail men, however, is confidence. Part of it is because women know they will likely live longer than their male counterparts, says Foss. Another part is an unrealistic fear of losing everything.

“Women now make up more than half of the professional and technical workforce in the U.S. They are earning postsecondary degrees at a faster rate than men and the wage gap, particularly for younger women, is closing,” says Foss. “And yet, the lack of confidence persists.”

This may be why landing a male investor as a client or getting him to invest in a new idea is much easier than a female investor, says Chris Markowski, president of Markowski Investments. With men, you can paint a picture of fancy cars, big houses and endless gadgets, whereas women aren’t as easily impressed, Markowski says. “You can push a man’s greed button much more.”

Men and women may have different investing styles, but — or because of that precisely — they have a lot to learn from each other. Women tend to be more conservative and men tend to be more aggressive. For couples, then, working together to find a happy medium can result in a sound, long term investing plan that will benefit both sides.

“It’s really smart to have both parties involved in the decision making,” says United Capital’s Corey. “If they are both part of the process, they will make better financial decisions.”

 

Donna Fuscaldo is a freelance writer based on Long Island, NY. Her work appears on Foxbusiness.com, Bankrate.com and Glassdoor.com.

Investing Habits of the Wealthiest 1%

In 2014, the wealthiest 1% of investors outperformed everyone else by nearly 40%. It’s only human to wonder why. Is there a secret performance-enhancing sauce to their investing strategy?

Not necessarily. In fact, Warren Buffett – the ultimate one-percenter, if you will – is a known proponent of investing in index funds, believing that over the long term, this low-cost strategy outperforms those who pay high investing fees. We don’t want to make too much of a single year’s results; it’s possible that the uber-wealthy (the top 1% of investors in our study synced $5 million or more) aren’t better investors than everyone else; they could have gotten lucky.

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Nonetheless, the top 1% may exhibit certain behaviors worth emulating. A 2013 Fidelity Millionaire Outlook study conducted among Generation X/Y investors (those aged 48 or younger with investable assets of at least $1 million, excluding workplace retirement accounts) found they are highly involved in how their assets are invested. That doesn’t mean they are on the phone with their advisor ten times a day, but they do understand how the stock markets work and know the importance of creating a plan and sticking with it. Here are three investing habits that could benefit anyone.
 

1. Keep emotions in check

Human emotions are hard to control and that’s particularly true when it comes to money.  Panic can easily set in and is often the reason investors buy high and sell low. “People tolerate risk very well when the markets are popping up but when they are going down, risk suddenly becomes the enemy,” says Taylor Gang, principal wealth manager at Evensky & Katz / Foldes Financial Wealth Management, which manages about $1.6 billion in assets for clients with assets anywhere from $1 million to $10 million. “The key is to prevent this human emotion from taking over and that’s where many 1 percenters succeed.”

Moving in and out of stocks to chase the market’s ups and downs may seem like a smart plan, but in the long run, being disciplined wins the race. In 2014, the median 1-percenter had portfolio turnover of 10% while everyone else churned their portfolio 13%.  That’s 30% lower than everyone else.
 

2. Invest with taxes in consideration

Nobody likes to pay taxes, yet many investors ignore the tax ramifications of their investing decisions. That could turn out quite expensive for those in the top tax bracket. “When you are looking at a 35% capital gains tax, when the average person has 10% to 15%, you have to become tax savvy,” says Kimberly Foss, founder of Empyrion Wealth Management, who manages money for individuals with $3 million or more in investable assets.

Because of that, many high net worth investors employ tax-advantaged strategies that help their performance and keep their tax rate in check. Consider this: the 1% are five times more likely to own Vanguard’s Intermediate-Term Tax-Exempt Fund (VWIUX) than the 99%.
 

3. Don’t time the market, or be swept up by hype

“Successful investors are often skeptical,” says Gang. “They do the appropriate amount of due diligence and they investigate and make decisions with the benefit of information.” Consider this: Alibaba (BABA), the Chinese e-commerce company, was the hottest IPO of 2014, yet the top 1% were only half as likely to own that stock at the end of 2014 as the rest of us. An IPO may seem attractive — after all, you are getting in on a company poised for growth — but often that’s already priced into the shares and the ones who will benefit are those who held a piece of the company when it was private. “An IPO is not a great panacea,” says Jeremy Kisner, senior wealth adviser at Surevest Wealth Management, who manages investors with $1 million to $10 million in assets. “It’s a panacea for the people who held the stock when it was private.”

The 1% are also half as likely as the 99% to own Facebook (FB), Apple (AAPL), Twitter (TWTR), and Ford (F), and only a third as likely as the 99% to own Tesla (TSLA): stocks that otherwise top the popularity charts among everyday investors. So what are they most likely to own? It comes as no surprise, perhaps, that on top of that list is Warren Buffett’s Berkshire Hathaway Class A shares (BRK/A), which traded at $224,675 at close, January 8, 2015.
 

There is no “Secret Sauce,” so don’t pay anyone who claims to know the recipe

Of course, being wealthy doesn’t make one immune to bad investing decisions at all. In this study, for example, the top 1% are just as likely to be overly exposed to equities vs bonds relative to their risk profile (according to SigFig’s data and a risk assessment questionnaire). And they pay on average 17% more in fees as a percentage of assets, translating to $8,000 a year in investing costs that are often easily avoidable.

As Buffett wrote in his 2013 letter to shareholders,

“The goal of the non-professional [investor] should not be to pick winners – neither he nor his “helpers” can do that – but should rather be to own a cross-section of businesses that in aggregate are bound to do well.”

Donna Fuscaldo is a freelance writer based on Long Island, NY. Her work appears on Foxbusiness.com, Bankrate.com and Glassdoor.com.