Why your retirement fund needs ETFs

They're easy to trade and offer the advantages of traditional mutual funds, but without the hefty fees charged by active managers.

By Benzinga May 30, 2013 12:38PM
 Couple with financial planner copyright moodboard, CorbisBy Tim Parker

Not everybody is a stock market junkie.

They don't all watch CNBC so much that they know every personality by name. Many don't know anything about a moving average and frankly, don't care.

Sure, you could argue that people may be better off financially if they learned a little more about how the markets worked, but we’'l save that debate for another time.

Even the non-junkies, however, have heard of mutual funds. They are sort of like dinosaurs when compared to the newer products available, but they still offer choices in most employer-sponsored retirement accounts.

Mutual funds come in two varieties: actively and passively managed. Actively managed funds employ a team of managers to execute a strategy to beat the market. The problem is twofold: First, the strategy doesn't work over a sustained period of time and second, the team is going to charge the fund (ultimately you as a shareholder) some hefty management fees.

Passively managed funds aren't out to beat anything. They're set up to mirror the market. Mirroring the market can be done with very little effort. As a result, these funds don't come with high management fees. The best long-term strategy is a portfolio built around passively managed funds. Some people (mainly, those who are active managers) will disagree, but statistics indicate that mirroring the market produces better returns than trying to beat it.

To the delight of many, an increasing number of 401(k)s and other retirement accounts are now including exchange-traded funds or ETFs as offerings for employees. Here's why you should use them for not only your employee sponsored accounts but also an IRA or brokerage account.

An ETF, like a passively managed mutual fund attempts to mirror the market as a whole or a certain sector. There are ETFs for just about every economic sector. If you want to invest in Vietnam, you can do it through an ETF. If you want to invest only in the financial sector, again, there's an ETF for that. Also, like passively managed mutual funds, they're often cheaper than actively managed funds.

The main difference between an ETF and a mutual fund is that the ETF trades on a stock exchange just like a stock; a mutual fund does not. Instead, it rebalances at the end of each day.

Why should you choose ETFs?

You can't control whether the world's investment markets will go up or down tomorrow, next month, or next year. You can, however, control the fees you pay and over the course of 30 years, those fees can add up to more than six figures worth of lost income in your retirement accounts.

Jack Bogle, Vanguard Group founder and known as the father of the index fund, said, "Asset allocation is critically important; but cost is critically important too -- All other factors pale into insignificance"

There are low-fee mutual funds just as there are high-fee ETFs, but when given the choice, investors will often choose ETFs. They're often lower in overall fees and easier to understand.

Some of the more popular ETFs include SPDR S&P 500 (SPY), Financial Select Sector SPDR (XLF), SPDR Gold Trust (GLD), and iShares Russell 2000 Index (IWM).

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