Protect Your Wealth With Exchange-Traded Funds (ETFs)

In the post Destroy 50% of your wealth investing in mutual funds, I showed you how investing in mutual funds with high expense ratio can cost you 50% of your potential gain. With this in mind, I went back to review my IRA portfolio and found a fund that charges 1.23% (above my 1.0% maximum tolerance). This does not seem expensive, but it can cost me 30% of money invested if I keep it in the fund for 30 years.

I also hinted that I have been looking at another class of investment called Exchange-Traded Funds or ETFs. I did my initial research on Yahoo! Finance and About.com. Here are the highlights:

• ETFs are essentially a hybrid between individual stocks and mutual funds with characteristics of both
• Like mutual funds:
  • ETFs are portfolios of many stocks, but their prices do not necessary match the net asset value (NAV) of the underlying stocks. It could be traded at a premium above the NAV, or at a discount below the NAV.
  • ETFs are usually set up in categories similar to mutual fund — i.e., small-growth, mid-blend, large-index, specialty-real estate, international, etc.
  • ETFs have expense ratio, but usually much lower than mutual funds of the same asset class
• Like stocks:
  • ETFs can be traded throughout the day
  • Traders can short or buy ETFs on margin
  • Brokers charges trade commission to buy and sell ETFs
  • ETFs suffer from bid-ask spread, meaning you have to buy at a higher ask price and sell at the lower bid price; effectively, losing the 1/8 spread.
• Lastly, ETFs are more tax-efficient than mutual funds. You can see the chart below — the big drop in HFCGX value is the huge distribution at the end of 2006. Luckily, this fund was in my IRA, so no tax!

Right now, I have enough money invested such that it is more expensive to invest in mutual funds than ETFs. So today, I went ahead and sold HFCGX and traded it for VB.

Here are some related posts from other Bloggers:

• Advanced Personal Finance: ETF Basics - What Everyone Should Know

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