As thestock market surged ever higher in the 1990s, many
investors were content to let mutual fund managers find the
rightstocks for them. After all, the nation's leading mutual funds
were racking up stellar gains, and it was of little concern that
investors had to pay 1% to 3% in annual fees for the high-priced
salaries paid out to many fund managers.
But in the next decade, parking yourmoney in amutual fund no
longer seemed such a wise move -- many of the most popularfunds
failed to even keep up with their benchmarks (such as the S&P
500 or theNasdaq Composite Index ). Add to that the funds tacked on
onerous management fees.
Investors have had enough, and they have been pulling out of
mutual funds steadily in the past five years. In fact, with $11.6
trillion in mutual fund assets at the end of 2011, investors took
more than $125 billion out of stock-focused mutual funds in 2012,
according to theInvestment Company Institute (ICI).
Where's that money going? Exchange-traded funds (
), which trade on the major stock exchanges with their ownticker
These funds, which first appeared roughly 20 years ago, allow
you to target specific investment angles such as gold, energy and
even foreign countries. Yet they do so without the active hand of a
high-pricedfund manager . Instead, ETFs are generally "passive,"
which means they own a select group of stocks (orbonds ) and then
hold them for a very long time. That means lower trading costs and
very little managementoverhead , which adds up to much lower annual
For example, the FidelityAdvisor Large Cap Bfund charges 2.04%
in annual expenses. The fund owns a range ofblue chip stocks such
Apple (Nasdaq: AAPL)
JP Morgan (
. In contrast, the
SPDR S&P 500ETF (
owns a very similar basket of stocks and charges just 0.09% in
annual expenses. In effect, that Fidelity fund would have to
generate annual returns of at least 2% just to deliver the same
net-of-fees result as the ETF.
ETFs had their first breakout year in 2008, when investors
poured $169 billion into them. Most of the money went straight into
ETFs that owned U.S. stocks. Fast-forward to 2012, and times have
surely changed. ETFs received a record $191 billion last year,
though the bulk of that money was earmarked forbond ETFs,
international stocks and sector-focused funds. In fact, the amount
of money tied up in ETFs now exceeds $1.35 trillion, more than
double the amount seen at the end of 2008.
It should come as no surprise that Vanguard, which was known for
very low expense loads in mutual funds, has sought to become a
leading player in ETFs. Indeed Vanguard is now the industry's
third-largest in terms of stock-and-bond ETF assets under
management, well ahead of traditional retirement fund firms such as
Fidelity and T. Rowe Price.
Barclays' group ofiShares funds remains the top dog, with
roughly 40%market share , while State Street GlobalAdvisors , with
its pioneering SPDRs program, controls roughly one-quarter of the
market. In effect, Barclays, State Street and Vanguard now control
more than 80% of this market. Smaller rivals such as Wisdom Tree,
Van Eck, PIMCO and Invesco's PowerShares division continue to try
to take market share from the bigger players in 2013 with
Where's the action right now? Well, the top three most popular
funds in 2012 (in terms of new assets gathered) were the
VanguardEmerging Markets (
iShares iBoxx $Investment Grade Corp. Bonds (
iShares MSCI Emerging Markets (EEM)
These funds are heavily traded, which means the gap between the
price you would pay to buy them and the price you would receive
when you sell them (known as thebid/ask spread ) is narrow, usually
just a penny. Conversely, there are now hundreds of smaller ETFs
that don't see as much interest and as a result often sport wider
bid/ask spreads that can eat into your profits. As a good rule of
thumb, focus on ETFs that trade at least 100,000 shares daily.
Action to Take -->
As ETFs rise in popularity, the number of ETFs available has risen
from 113 a decade ago to more than 1,200 today. The key is to
identify the specific parts of the domestic or globaleconomy you
would like to target, then find out which ETFs are available to
meet them. If you findmultiple ETFs that appear to match an
identical topic, then focus on the ETF that has the lowestexpense
ratio and the highest daily tradingvolume .
This article originally appeared on InvestingAnswers.com:
Forget Mutual Funds
-- Try This Simple, Low-Cost Alternative Instead
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