DIY Portfolio Management

Exchange Traded Funds (ETFs) are growing. Investors are choosing low annual expense and market return over high annual expense and promised performance.

Total ETF inflow is growing faster than Mutual Fund inflow. ETF inflow grew from $42.5 billion in 2000 to $54.4 billion in 2004. In contrast, mutual fund inflow fell from $309.4 billion in 2000 to $180.3 billion in 2004. Standard & Poors Depositary Receipts Trust (SPY) is the largest and oldest ETF. From the one fund SPY started in 1993 the number of ETFs has grown to 150 in 2004.

Growth of ETFs is fueled by investors searching for market performance. About 20% of conventional mutual funds do beat the market. The puzzle is which funds will win, in the future. ETFs, on the other hand, have a reasonably good record of matching the performance of their underlying index. For instance, in 2004, SPY value grew 10.92% and the value of the underlying S&P 500 index grew at 10.88%. The promise of the conventional mutual fund is that it will deliver superior results. The promise of the ETF is that it will match the performance of its underlying index.

Expense for ETFs is less than for conventional mutual funds. A prime reason for the mutual funds' higher expense is that pros perceived capable of superior results are more expensive than technicians paid to duplicate the holdings of an index. ETFs are passive investments and don't require the active management of pros. Investors moving money from mutual funds to ETFs are trading promised performance and high expense for market returns and low annual expense. ETFs generally have expense ratios below 1. SPY's expense ratio is .12. Expense ratio is percent of assets consumed by fees annually.

Investors sticking with mutual funds have a couple of things going for them. Eliot Spitzer has used his New York State Office of Attorney General to scare/shame mutual funds into minding fiduciary duties to their investors. The growth of ETFs is pressuring mutual funds to reduce their expenses and to introduce ETFs mimicking mutual funds. Investors sticking with mutual funds might benefit from the growth of ETFs. However, mutual funds might have a hard time delivering. Slowing growth or actual decline in fund size will make it difficult to reduce their expenses enough to keep investors happy. The more investors defect the fewer left to share the expense.

ETFs trade like stock equities. They can be bought and sold whenever the market is open. They can be shorted, purchased on margin, and optioned. Most brokers charge a commission for every buy and sell transaction. This can be a problem for small investors building a portfolio with monthly contributions. There is at least one broker that charges an annual fee rather than per trade commissions.

ETFs are passive. They only trade when changes are made to the composition of the underlying index. Fewer trades mean less tax consequence. Mutual funds often have taxable capital gains, sometimes even in years when the fund has declined in value (sell winners and hold losers).

That 20% of mutual funds beat the market is a premise. It assumes multiply years and a market defined as the S&P 500. Meg Richards writing for The Associated Press reported that for 2004:

- The S&P500 bested 61.6% of actively managed large-cap funds.

- The S&P400 bested 61.8% of actively managed mid-cap funds.

- The S&P600 bested 85% of actively managed small-cap funds.

The probability of a mutual fund having beaten the market in 2004 is low. Of course, relative performance changes from year to year. Relative performance, of active versus passive management, changes. Relative performance, of individual actively managed funds, changes.

The best ETFs strategy for small, beginning, busy investors is to 'buy and hold' SPY. If you are bigger, experienced, or have time on your hands you can try a more active strategy. A strategy that beat the S&P500 over the last three years is to hold equal amounts of five large diversified ETFs and rebalance weekly. This strategy is in some ways just an expansion of our definition of 'the market' beyond the S&P500. This strategy since inception 3 years ago has beaten the S&P500 just over 1% annualized. This small gain means rebalancing weekly is only viable when it is without trading cost. A more aggressive strategy is to monitor 50 ETFs and hold the most oversold, rebalancing weekly. This strategy since inception 2/27/04 has beat the S&P500 by 16%.

Remember. ETFs' popularity is on the rise. They trade like stocks. They have lower annual expense than mutual funds. Their objective is to mimic the performance of an index. They don't beat or lose to the market, they are the market. It is usually best for low maintenance, 'buy and hold' investors to define the market as broadly as possible.

Lyle Wilkinson, investor, trader, author, MBA Helps individuals learn to self direct their stock portfolios. Book, e-book, PowerPoint "DIY Portfolio Management" http://www.diyportfoliomanagement.com lyle@diyportfoliomanagement.com

---

Trapeze Artist - Swinging with the Stock Market

When we go to the circus we see a trapeze... Read More

Rebalance And Diversify

The stock market has not been very kind to your... Read More

Structured Settlement; Lawyers in NY and Mutual Funds

Minority Report the movie may not be far off if... Read More

Buying Stocks and the Importance of Correct Timing

An investor can find and research the best stock on... Read More

Dollar Cost Averaging

Dollar cost averaging is one of the most popular ideas... Read More

Its A Duck

If it walks like a duck, quacks like a duck... Read More

How Covered Calls Turned a Trader Around

Sidney felt sick as she looked at her latest OptionsXpress... Read More

Perfect Storm

Having lived aboard a sailboat for 2 years I was... Read More

Eternal Sunshine

There is a current movie entitled "Eternal Sunshine of the... Read More

Buy and Hold: How to Perpetuate Your Investment Losses

A recent cartoon in my daily newspaper showed two guys... Read More

Inverted Interest Rates

Inverted interest rates? What's that? Who cares? Even if you... Read More

Trading For A Living - Part 1

There can't be many traders who haven't at least considered... Read More

Good Stock Market Tip; Good Return!

Forget making a profit; instead focus on the income provided... Read More

Discover the Biggest Trading & Investing Online Mistake

Any online investor / trader seeks an excellent off or... Read More

Complacency

During the month of January the Dow Jones Industrial Average,... Read More

What the Hell is a Stock option?

A 'stock option' is a contract between two parties giving... Read More

How to Find Value in No Load Mutual Fund Investing

What are you thinking when it comes to your no... Read More

Pension Plans

If you have a pension plan at work you will... Read More

Investing in the Stock Market - When To!

Is really not as important as to how you invest... Read More

Stock Trading Secrets?

How often have you come across an advertisement or e-mail... Read More

Discipline

One of the great "secrets" of successful people is discipline... Read More

The Top 10 Reasons to Invest in Mutual Funds

Everyone who follows the financial news has heard of mutual... Read More

Investment Discipline

One of the great "secrets" of successful people is discipline... Read More

Is The Bear In The Cage?

For the last few weeks we have seen the stock... Read More

More Window Dressing

Two weeks ago I wrote about what the Securities and... Read More

Mid-Cap Stocks: Asset Class with an Identity Crisis

Much like the middle child, mid-cap stocks have long struggled... Read More

Downdraft

For the year 2000 we have seen hundreds of mutual... Read More

No Load Mutual Funds: Investment Hype vs. Investment Help

With the internet such a huge part of our daily... Read More

Complacency Indicator

If you haven't heard of the technical indicator with the... Read More

What To Buy?

Now that you have some money burning a hole in... Read More

The Stock Market Investor?s Worst Enemy

Every stock market investor faces one primal enemy. An enemy... Read More

Lies, Damn Lies and Mutual Fund Returns

How many times has this happened to you? You're at... Read More

A Common Misconception about Stock Prices

I cringe every time I hear a novice investor tell... Read More