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Can You Invest Solely in ETF’s?

This is a guest post by the Intelligent Speculator which is a blog about investing, news and market events. It also supplies readers with free stock picks with the goal of  generating new investment ideas. You can visit the blog at IntelligentSpeculator.net and subscribe to the RSS feed here.

As regular readers of the Intelligent Speculator know, we are big fans of Exchange Traded Funds (ETF’s) which are one of the fastest growing products in the market.  Were it not for the fact that financial firms and advisors have less incentives to sell ETF’s than other investments such as mutual funds (that provide them with annual fees), the growth would probably be even more spectacular.

Having said that, ETF’s did not have the easiest year in 2008 as you can imagine and in fact after 5 years of annual asset growth over 35%, they actually declined in 2008 according to a recent report by Citigroup.

That same report also gave some interesting numbers regarding the asset classes now being sold through ETF’s.  Only 6 years ago, equities represented 97% of the underlying of ETF’s! Only six years later, that has already started to change with fixed income now representing 6%, commodities 11% and FX 4%. That is a major change and in many ways a sign of things to come in my opinion. For most investors, ETF’s represent the easiest and cheapest way to gain exposure in a variety of different sectors or asset classes. Investing in currencies or commodities was done by pension funds or hedge funds only a few years ago but it is now just as easy to do so for individual investors.

It might not be 100%, but a very large majority of individuals and professionals believe that diversification represents an important way to gain the same return but with less downside risk.  20 years ago that meant buying bonds, private investments, etc. The major problem with that strategy is illiquid investments are often very expensive if you are not pouring a major amount of capital.  A prime example is looking at the prices of a bond when you are buying $50,000 worth.  It is understandable of course that sellers will give better prices to buyers of millions of dollars as it is an easier trade for them.  Take a few percentage points here and there and you will see just how much of an impact it can have over a life of savings and investing.

In many ways, ETF’s provide a viable alternative as they offer the opportunity to get broad (corporate bonds) or specific (1-3 year treasuries) positions that will not cost you much in terms of commission.  Furthermore, ETF’s will get you much better pricing and potentially much improved returns over the long term.

Because of that, I believe that in most cases, investors can keep over 90% of their portfolios in ETF’s.  Of course, the more money you have to manage, the greater the possibilities which at that point, ETF’s might not represent as much of a bargain.  But until I have $1 million looking for a good investment, ETF’s will be just fine for my needs.

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{ 15 comments… add one }
  • Kathryn February 5, 2009, 11:17 am

    We do. We have a Couch Potato portfolio described well here http://www.canadianbusiness.com/my_money/investing/article.jsp?content=20060405_144810_2764

    We like the low fees, the balanced risk and the automatic annual rebalancing.

  • Mark Wolfinger February 5, 2009, 1:28 pm

    One way to invest in ETFs with additional safety to to trade only those ETFs that have listed options. Next, you adopt coservative, risk-reducing option strategies on thsoe ETFs.

    For option newbies, the two best strategies are covered call writing and collars.

    Mark
    http://blog.mdwoptions.com/options_for_rookies/2008/07/collars-the-ult.html

  • Sebastian February 5, 2009, 1:42 pm

    I’ve just finished reading A random walk down Wall Street which pretty much backs up the topic of this post with decades of data and research into the area.

    When I get to the point that I can invest, the bulk will be through ETFs and potentially doing what Mark suggests. Using options as an income method through covered calls and dabbling in collars for protection.

    I would diversify the rest of my portfolio with REITs, money markets and bonds.

  • Guy Davis February 5, 2009, 3:20 pm

    Hi, I’m in a mix of stock and bond ETFs (basically Couch Potato). My only concern is that I hold only iShares, so while the asset allocation is spread across Canadian and international equity plus bonds, it’s all through Barclay’s bank (iShares). So am I really diversified?

    What if iShares (Barclay’s) collapsed? I know it seems unlikely, but never say never. Should I also be trying to spread my diversification across various ETF providers to avoid disaster if one were to collapse?

  • amit February 5, 2009, 3:31 pm

    I have over 90% of my portfolio in ETFs, well diversified amongst Real Estate ETFs, Dividend paying ETFs, Currency ETFs, Developed/Emerging market ETFs, sector ETFs, Canadian ETFs.

    Everything that I can think of there is one or other ETF available. I like them, and yes, I don’t have a million dollars (yet) so they are okay for my couch potato portfolio too. I just Dollar-Cost Average once in a while (buying once every 3 months or once every 6 months (sometimes once every year)) and never sell them. I am investing in ETF, not day-trading these.

    I keep a chart by comparing my portfolio with SPY every time I purchase something, just to see whether my portfolio is doing better than the market or not.

    For the 10% portfolio that`s not in ETFs, I own MLPs and REIT stocks such as XTEX, SPH, SJT, TPP, HCN, O, RYN, KMP, and also WFC and ASBC.

  • Frank February 5, 2009, 3:47 pm

    Surely, you must know that ETFs charge annual management fees just like other mutual funds. You didn’t think that they were operated as charities did you? And it cannot surprise anybody that the huge growth in them over the past decade was fuelled by the fact that those fees are higher than equivalent open-end index mutual funds. Can it?

    ETFs have several advantages over open-end mutual funds. They trade like stocks, so you can short them, buy them on margin, and day-trade them. And in some cases you can get small-scale access to exotic asset classes not available elsewhere.

    But most of the time, most people are better off in an open-end no-load mutual fund that follows the same index as the ETF. The management fees will be lower and transactions in and out will be free.

  • Dividend Growth Investor February 5, 2009, 3:49 pm

    The most important think when selecting ETF’s is to understand the strategy behind the fund. There have been a lot of developments recently including currency harvest funds, as well as other “acive strategy” based ETF’s which capitalized on short-term trends.

  • CanadianFinance February 5, 2009, 4:54 pm

    I’m a huge fan of ETFs and the TD eFunds. That said there are two places where I would stay from index investing…

    Once I get a new house and mortgage, I will begin a Smith Manoeuvre and buy Canadian stocks directly so that I can specifically go after strong, dividend paying companies without the drag of any fees.

    The second is Canadian REITs. The MER is a little high on these, a better return could likely be achieved by buying the largest REITs in the index.

  • Mark February 5, 2009, 11:37 pm

    I’m thinking of using a ETF spread portfolio within my TFSA (mainly to support my RRSP), is this a wise thing todo or am i better using something else?

  • Future Generali February 6, 2009, 6:06 am

    Thanks for this very informative post. This is a nice blog and will be looking forward to read more from you.

  • thomas February 7, 2009, 3:22 am

    I really like ETFs as investment vehicles. The diversification abilities and ease of purchase make them a viable option for investing.

  • Canadian Money Review February 8, 2009, 11:39 am

    Frank:

    The MER for the iShares ETF “XIU” is 0.17%. I’d be curious to see which index mutual funds are lower than that (maybe those exist, but I simply don’t know them).

  • Stan February 9, 2009, 2:01 am

    CMR/Frank, there is no Canadian index fund with a lower MER than XIU at .17. The index mutual funds offered by the big banks and other providers range in the .65/.70 MERs, and more in many cases. The closest is TD e-Series Canadian Index, at .31, which is ideal for pre-authorized purchases since it can be bought in small amounts (which is the main advantage of the index mutual funds). When enough money is amassed to justify the trading expenses, it would be better to sell the index mutual fund and purchase the equivalent ETF. This is what I do with RBC Canadian Index/XIU. Very practical and it avoids the long-term drag of a higher MER on the index fund. If you’re going the passive investment route, why pay higher fees than absolutely necessary?

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