The first rule any investor learns is that you always want to remain as diversified as possible. That is the primary advantage of trading ETFs. ETFs allow you, for example, to put some money to work on the S&P 500 with the SPDR S&P 500 (SPY). The ETF is designed to track the performance of the S&P 500, so if the market goes up, so does your investment, but you are not vulnerable to a major downswing if any one particular stock runs into trouble. Of course, this limited risk also translates to limited upside, but that is a risk/reward trade off that an increasing number of investors are willing to accept.
You can see just how accurately SPY can track the broad S&P 500 Index in the chart below:
Chart courtesy www.stockcharts.com.
With ETFs becoming more popular, we are seeing a lot more crop up, and with the increased competition ETF managers are in a price war to attract the most customers.
Traditionally, Vanguard has been considered the low cost provider for ETFs, but last year it had its fees undercut by Charles Schwab. Vanguard was forced to react, and it countered Schwab by lower its fees earlier this year.
Vanguard, on average, charges investors an average management fee of just 28 basis points, but it wants to see that drop even lower. The company's head of retail, Nick Blake, recently gave a talk where he suggested that ETF providers could profit even if they were to drop their management fees to zero. It sounds bizarre, but he claims that providers, assuming they have a large enough size, can turn a profit just from lending out their securities. A spokesperson for Vanguard said the company currently has no plans to launch a no-load ETF.
This plays into the hands of big ETF players such as BlackRock (BLK) and State Street (STT). BlackRock is already moving into low-cost ETFs, having launched a new low-cost fund just this past October.
Companies that have enough size will be able to lower costs more than the smaller players, and as a result attract more capital. There is a lot of money to fight for, with assets under management at ETFs doubling over the last four years to $2 trillion globally.
Traditionally, ETFs have been used mainly by financial institutions, but retail investors have started to warm up to them, and now that they have gone mainstream you can expect to more, and cheaper ETFs launch in the coming years.
What that means for the average investor is that we are going to see more options, and easier ways to diversify our money in the market, at costs much lower than what we are currently paying.
Michael Fowlkes is a financial writer who has been with the Fresh Brewed Media family since 2004. Over the course of his tenure with Fresh Brewed Media, he has worn many hats, including portfolio manager, options analyst, and writer. Michael received his undergraduate degree from Virginia Tech in Accounting and got his start in finance working as a stock trader for six years at Chase Investment Counsel in Charlottesville, Va.