Читать книгу Investing in ETFs For Dummies - Russell Wild - Страница 7

Clients I’ve worked with are often amazed that I can put them into a financial product that will cost them a fraction in expenses compared to what they are currently paying. Low costs are probably what I love the most about ETFs. But I also love their tax efficiency, their transparency (you know what you’re buying), and the long track record of success for indexed investments.

The cost advantage: How low can you go?

In the world of actively managed mutual funds (which is to say most mutual funds), the average annual management fee, according to Morningstar, is 1.25 percent of the account balance. That may not sound like a lot, but don’t be misled. A well-balanced portfolio with both stocks and bonds may return, say, 6 percent over time. In that case, paying 1.25 percent to a third party means that you’ve just lowered your total investment returns by more than one-fifth. In a bad year, when your investments earn, say, 1.25 percent, you’ve just lowered your investment returns to zero. And in a very bad year … you don’t need me to do the math.

I’m astounded at what some mutual funds charge. Whereas the average is 1.25 percent, I’ve seen charges 10 times that amount. Crazy. Investing in such a fund is tossing money to the wind. Yet people do it. The chances of your winding up ahead after paying such high fees are next to nil. Paying a load (an entrance and/or exit fee) that can total as much as 8.50 percent is just as nutty. Yet people do it.

In the world of index funds, the expenses are much lower, with index mutual funds averaging 0.87 percent and ETFs averaging 0.53 percent, although many of the more traditional indexed ETFs cost no more than 0.20 percent a year in management fees. A good number – 122 at last count – are 0.10 percent or less. Some are so low as to be negligible.

Numerous studies have shown that low-cost funds have a huge advantage over higher-cost funds. One study by Morningstar looked at stock returns over a five-year period. In almost every category of stock mutual fund, low-cost funds beat the pants off high-cost funds. Do you think that by paying high fees you’re getting better fund management? Hardly. The Morningstar study found, for example, that among mutual funds that hold large blend stocks (blend meaning a combination of value and growth … an S&P 500 fund would be a blend fund, for example), the annualized gain was 8.75 percent for those funds in the costliest quartile of funds; the gain for the least costly quartile was 9.89 percent.

Why ETFs are cheaper

The management companies that bring us ETFs, such as BlackRock, Inc., and Invesco PowerShares, are presumably not doing so for their health. No, they’re making a good profit. One reason they can offer ETFs so cheaply compared to mutual funds is that their expenses are much less. When you buy an ETF, you go through a brokerage house, not BlackRock or Invesco PowerShares. That brokerage house (Merrill Lynch, Fidelity, TD Ameritrade) does all the necessary paperwork and bookkeeping on the purchase. If you have any questions about your money, you’ll likely call Schwab, not BlackRock. So unlike a mutual fund company, which must maintain telephone operators, bookkeepers, and a mailroom, the providers of ETFs can operate almost entirely in cyberspace.

ETFs that are linked to indexes do have to pay some kind of fee to Dow Jones or MSCI or whoever created the index. But that fee is nothing compared to the exorbitant salaries that mutual funds pay their stock pickers, er, market analysts.

An unfair race

Active mutual funds really don’t have much chance of beating passive index funds – whether mutual funds or ETFs – over the long run, at least not as a group. (There are individual exceptions, but it’s virtually impossible to identify them before the fact.) Someone once described the contest as a race in which the active mutual funds are “running with lead boots.” Why? In addition to the management fees that eat up much of any gains, there are also the trading costs. Yes, when mutual funds trade stocks or bonds, they pay a spread and a small cut to the stock exchange, just like you and I do. That cost is passed on to you, and it’s on top of the annual management fees previously discussed.

It’s been estimated that annual turnover costs for active mutual funds typically run about 0.8 percent. And active mutual fund managers must constantly keep some cash on hand for all those trades. Having cash on hand costs money, too: The opportunity cost is estimated to be in the neighborhood of 0.4 percent.

So you take the 1.25 percent average management fee, and the 0.8 percent hidden trading costs, and the 0.4 percent opportunity cost, and you can see where the lead boots come in. Add taxes to the equation, and while some actively managed mutual funds may do better than ETFs for a few years, over the long haul I wouldn’t bank on many of them coming out ahead.

Uncle Sam’s loss, your gain

Alas, unless your money is in a tax-advantaged retirement account, making money in the markets means that you have to fork something over to Uncle Sam at year’s end. That’s true, of course, whether you invest in individual securities or funds. But before there were ETFs, individual securities had a big advantage over funds in that you were required to pay capital gains taxes only when you actually enjoyed a capital gain. With mutual funds, that isn’t so. The fund itself may realize a capital gain by selling off an appreciated stock. You pay the capital gains tax regardless of whether you sell anything and regardless of whether the share price of the mutual fund increased or decreased since the time you bought it.

There have been times (pick a bad year for the market – 2000, 2008 …) when many mutual fund investors lost a considerable amount in the market yet had to pay capital gains taxes at the end of the year. Talk about adding insult to injury! One study found that over the course of time, taxes have wiped out approximately 2 full percentage points in returns for investors in the highest tax brackets.

In the world of ETFs, such losses are very unlikely to happen. Because most ETFs are index-based, they generally have little turnover to create capital gains. To boot, ETFs are structured in a way that largely insulates shareholders from capital gains that result when mutual funds are forced to sell in order to free up cash to pay off shareholders who cash in their chips.

No tax calories

The structure of ETFs makes them different from mutual funds. Actually, ETFs are legally structured in three different ways: as exchange-traded open-end mutual funds, exchange-traded unit investment trusts, and exchange-traded grantor trusts. The differences are subtle, and I elaborate on them somewhat in Chapter 3 and throughout Part II. For now, I want to focus on one seminal difference between ETFs and mutual funds, which boils down to an extremely clever setup whereby ETF shares, which represent stock holdings, can be traded without any actual trading of stocks. In a way it’s like fat-free potato chips (remember Olestra?), which have no fat calories because the fat just passes through your body.

Market makers and croupiers

In the world of ETFs, we don’t have croupiers, but we have market makers. Market makers are people who work at the stock exchanges and create (like magic!) ETF shares. Each ETF share represents a portion of a portfolio of stocks, sort of like poker chips represent a pile of cash. As an ETF grows, so does the number of shares. Concurrently (once a day), new stocks are added to a portfolio that mirrors the ETF.

When an ETF investor sells shares, those shares are bought by a market maker who turns around and sells them to another ETF investor. By contrast, with mutual funds, if one person sells, the mutual fund must sell off shares of the underlying stock to pay off the shareholder. If stocks sold in the mutual fund are being sold for more than the original purchase price, the shareholders left behind are stuck paying a capital gains tax. In some years, that amount can be substantial.

In the world of ETFs, no such thing has happened or is likely to happen, at least not with the vast majority of ETFs, which are index funds. Because index funds trade infrequently, and because of ETFs’ poker-chip structure, ETF investors rarely see a bill from Uncle Sam for any capital gains tax. That’s not a guarantee that there will never be capital gains on any index ETF, but if there ever are, they are sure to be minor.

The actively managed ETFs – currently a very small fraction of the ETF market, but almost certain to grow – may present a somewhat different story. They are going to be, no doubt, less tax friendly than index ETFs but more tax friendly than actively managed mutual funds. Exactly where will they fall on the spectrum? It may take another year or two (or three) before we really know.

Tax efficient does not mean tax-free. Although you won’t pay capital gains taxes, you will pay taxes on any dividends issued by your stock ETFs, and stock ETFs are just as likely to issue dividends as are mutual funds. In addition, if you sell your ETFs and they are in a taxable account, you have to pay capital gains tax (15 to 20 percent) if the ETFs have appreciated in value since the time you bought them. But hey – at least you get to decide when to take a gain, and when you do, it’s an actual gain.

ETFs that invest in taxable bonds and throw off taxable bond interest are not likely to be very much more tax friendly than taxable-bond mutual funds.

ETFs that invest in actual commodities, holding real silver or gold, tax you at the “collectible” rate of 28 percent. And ETFs that tap into derivatives (such as commodity futures) and currencies sometimes bring with them very complex (and costly) tax issues.

Taxes on earnings – be they dividends or interest or money made on currency swaps – aren’t an issue if your money is held in a tax-advantaged account, such as a Roth IRA.

What you see is what you get

A key to building a successful portfolio, right up there with low costs and tax efficiency, is diversification. You cannot diversify optimally unless you know exactly what’s in your portfolio. In a rather infamous example, when tech stocks (some more than others) started to go belly up in 2000, holders of Janus mutual funds got clobbered. That’s because they learned after the fact that their three or four Janus mutual funds, which gave the illusion of diversification, were actually holding many of the same stocks.

Style drift: An epidemic

With a mutual fund, you often have little idea of what stocks the fund manager is holding. In fact, you may not even know what kinds of stocks he is holding. Or even if he is holding stocks! I’m talking here about style drift, which occurs when a mutual fund manager advertises his fund as aggressive, but over time it becomes conservative, and vice versa. I’m talking about the mutual fund manager who says he loves large value but invests in large growth or small value.

One classic case of style drift cost investors in the all-popular Fidelity Magellan Fund bundle. The year was 1996, and then fund manager Jeffrey Vinik reduced the stock holdings in his “stock” mutual fund to 70 percent. He had 30 percent of the fund’s assets in bonds or short-term securities. He was betting that the market was going to sour, and he was planning to fully invest in stocks after it did. He was dead wrong. Instead, the market continued to soar, bonds took a dive, Fidelity Magellan seriously underperformed, and Vinik was out.

One study by the Association of Investment Management concluded that a full 40 percent of actively managed mutual funds are not what they say they are. Some funds bounce around in style so much that an investor would have almost no idea where her money was.

ETFs are the cure

When you buy an indexed ETF, you get complete transparency. You know exactly what you are buying. No matter what the ETF, you can see in the prospectus or on the ETF provider’s website (or on any number of independent financial websites) a complete picture of the ETF’s holdings. See, for example, http://finance.yahoo.com. If I go and type the letters IYE (the ticker symbol for the iShares Dow Jones U.S Energy Sector ETF) in the box on the top of the page, and then click the Holdings link on the left, I can see in an instant what my holdings are.

You simply can’t get that information on most actively managed mutual funds. Or if you can, the information is both stale and subject to change without notice.

Transparency also discourages dishonesty

The scandals that have rocked the mutual fund world over the years have left the world of ETFs untouched. There’s not a whole lot of manipulation that a fund manager can do when his picks are tied to an index. And because ETFs trade throughout the day, with the price flashing across thousands of computer screens worldwide, there is no room to take advantage of the “stale” pricing that occurs after the markets close and mutual fund orders are settled. All in all, ETF investors are much less likely ever to get bamboozled than are investors in active mutual funds.