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

---

Cash Is A Position

I go to the Money Show every year to visit... Read More

Money, Insanity and Wall Street

Money: the most charged word in the planet. It means... Read More

Oil Stocks CHK WLL - What Is Their Worth?

(1) CHK stock price $16.74, NAV $32.5CHK is my favorite... Read More

Historical Briefing: Stocks, Finance and Money

The World Bank claims that some two billion of the... Read More

Time Out

Are you paying any attention to your retirement savings? Do... Read More

Moving Averages

Every day on CNBC-TV they show a 200-day moving average... Read More

Trading vs Investing

I often hear from people, "I don't trade. I invest.... Read More

The Top 10 Reasons to Invest in Mutual Funds

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

Option Spread Trading

Spread trading is a technique that can be used to... Read More

Buying Mutual Funds

It looks like the market is ready to start up... Read More

Never Fall In Love!

Recently I watched my favorite football team lose a vital... Read More

The Big Bad Bear

The big bad bear is stirring again. So far he... Read More

Maximizing a Stock Market Investment

Maximizing a stock market investmentThere are several factors an investor... Read More

Fake Money

Reach in your pocket and take out that big roll... Read More

Swing Trading Strategies

Using Swing Trading Strategies and Technical Analysis when Trading Stocks... Read More

Top 25 Growth Funds

On Monday, November 25, 2000 Investor's Business Daily listed on... Read More

Why Buy and Hold?

Since I can remember, and that's a long time ago,... Read More

Trading For A Living - Part 1

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

Keep Your Profits

It looks like we have now entered a new bull... Read More

Mutual Fund Commissions

You have heard about a particular mutual fund from a... Read More

Managing Investing and Stock Market Risks

Reduce your investing and stock market risks by:Setting your sights... Read More

Stock Market Investing: Knowing When (and when not) to Sell

One of the greatest challenges of investing in stocks is... Read More

What Does it Take to be a Stock Trader?

It takes a total mental commitment to the task. It... Read More

Low Expense Ratio

One of the big advertising kicks today from mutual funds... Read More

Attitude Is [Almost] Everything

I often play a little game with myself when I... Read More

High Price/Earnings Ratios and the Stock Market: a Personal Odyssey

After some forty years of banking and investments, I retired... Read More

Stock Market Investments

If there is one term over-used when talking about making... Read More

Wall Street Paradigm

In 1960 an engineer working for a watch company in... Read More

Complacency Indicator

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

Stuff

I continually hear from economists, talking heads, other market letter... Read More

How to Maximize Your 401k Mutual Fund Returns

When it comes to 401k's there is an overabundance of... Read More

Market Success

Who are the successful investors?There are those who follow the... Read More

Dont Fight The Fed

One of the great truisms of Wall Street is "Don't... Read More