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The rise of ETFs and their biggest flaw

When you go grocery shopping and walk down the cereal aisle, are you overwhelmed by the number of varieties? There are probably too many choices. Today the same situation exists in the stock market. Investors have so many choices that you literally have tens of thousands of alternatives.

In the last 10 years, there has been a dramatic shift away from mutual funds and into exchange traded funds or ETFs. The amount of mutual funds peaked around the year 2000 and has remained pretty constant around 8000 funds. In the meantime, the number of publicly traded stocks has declined steadily and the amount of ETFs has been on the rise. Today the number of funds and ETFs is almost 3x the number of stocks available on US exchanges. If you add them all up, you have roughly 13,000 potential investment options between stocks, ETFs and mutual funds.

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In addition, ETFs now account for a huge amount of daily volume. In volume terms, seven of the 10 most actively traded securities on US stock markets were ETFs, not shares. ETFs now account for about 30 percent of all US trading by value and 23% by share volume.

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The flaw: the high cost of low expense ratios

The big shift to ETFs has largely been driven by the move from higher cost mutual funds and into lower cost ETFs. This makes sense to an extent and everyone looks smart when the bull market grinds longer and longer. However when a bear market hits especially one like 2008/9, expense ratio is far from the biggest cost of investing. What is? Watching your portfolio's value melt down because you didn't take protective measures by shifting to defensive assets. This is where a great money manager will prove their worth because in down markets you can make a big impact by not losing money! Asset allocation makes the difference not simple diversification.

Runnymede's use of ETFs

Runnymede has been a proponent of ETFs for many years before they became the popular trend. Back in an interview from Treasury Management International in 1995, Runnymede was on the cutting edge of ETF investing and developed a strategy called Index Equity Plus with the ETF SPY as its core holding. 

Today we continue to use ETFs in client portfolios. In smaller accounts, ETFs work well to give clients broad diversification. For example for a $10k account, it wouldn't be cost efficient to own 30 stocks because the transaction fees would eat into the returns. Instead, buying one ETF like IVV (iShares S&P 500) is free to trade at custodians like Fidelity and TD Ameritrade and is the equivalent of owning 500 stocks.

For larger accounts, we use ETFs for a couple of reasons. First, we like to a have piece of the portfolio (25-30% of equity allocation) that can be quickly liquidated and moved to cash when we feel like the risk of a bear market is considerable. Secondly, we use ETFs when we are looking at markets outside of the US like emerging or international markets where we want to have exposure with diversification.

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About the Author: Chris Wang

Chris Wang

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Please remember that past performance may not be indicative of future results.  Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Runnymede Capital Management, Inc.-"Runnymede"), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful.  Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions.  Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from Runnymede.  Please remember that if you are a Runnymede client, it remains your responsibility to advise Runnymede, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. Runnymede is neither a law firm nor a certified public accounting firm and no portion of the blog content should be construed as legal or accounting advice. A copy of the Runnymede's current written disclosure Brochure discussing our advisory services and fees is available for review upon request. Please Note: Runnymede does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to Runnymede's web site or blog or incorporated herein, and takes no responsibility for any such content. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly.

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