The last decade we have seen some pretty big moves in the market. Many investors were burned by the dot-com crash, and even more watched their portfolios crash during the recent recession. The volatility we have seen in recent years has taken its toll on investors, which are increasingly moving away from stocks and shifting their attention to broader index funds and ETFs.
The main advantage to using ETFs and index funds as investing tools is the lower volatility. Yes, you will experience ups and downs, but they will be fairly in-line with the broad market, which will always have a lower volatility than a basket of stocks pulled from it. The golden rule to successful investing is diversification, and that is why ETFs offer such a more acceptable level of volatility than mutual funds, which while diversified and much less so.
Lower volatility is not the only reason investors have turned their attention towards ETFs. Some ETFs cost lower than 0.1% of assets a year. When compared with the 1% that many mutual funds charge, the savings are enough to catch people's attention.
And then there is the matter of performance. Mutual fund managers want you to believe their professional experience picking stocks gives them an advantage over the overall market, but that is not always the case.
According to Morningstar, mutual fund managers that ran funds focused on large cap stocks earned their clients a return of 15.3% last year. Not too bad, but it failed to match the 16.4% return that similarly based ETFs gained during the same time period.
The trend is obvious. During the first eleven months of 2012, investors pulled over $119 billion from managed stock funds. During that same period they invested over $30 billion in stock ETFs, and an additional $154 billion into bond ETFs.
The biggest problem is that mutual funds can never be as diversified as ETFs, and that will always put them at greater risk should a stock turn south fast. Consider recent blowups such as Netflix (NFLX) and Chesapeake Energy (CHK). Both companies were doing great, and were widely held by mutual funds when they took big hits after poor management decisions pushed them out of favor among investors. Yes, their impact was felt by the ETFs that track them, but not nearly as much as the mutual funds that held shares.
Investors remember big blowups, and cases like Netflix and Chesapeake are not isolated events. A few other names that come to mind are Lehman Brothers, Enron and Bear Stearns… three companies that at one point seemed unstoppable. We all know how their stories ended.
Who is really to blame for people falling out of love with stock picking? Can we point the blame at fund managers and their fees, or does more responsibility rest on the shoulders of poor corporate management that has led to some high profile implosions in recent years?
There are no clear-cut answers. Each investor has his or her reasons, but what is for certain is that the trend is clearly in favor of the less volatile ETFs and index fund.