This is a guest post by the Intelligent Speculator which is a blog about investing, news and market events. It also supplies readers with free stock picks with the goal of generating new investment ideas. You can visit the blog at IntelligentSpeculator.net and subscribe to the RSS feed here.
As regular readers of the Intelligent Speculator know, we are big fans of Exchange Traded Funds (ETF’s) which are one of the fastest growing products in the market. Were it not for the fact that financial firms and advisors have less incentives to sell ETF’s than other investments such as mutual funds (that provide them with annual fees), the growth would probably be even more spectacular.
Having said that, ETF’s did not have the easiest year in 2008 as you can imagine and in fact after 5 years of annual asset growth over 35%, they actually declined in 2008 according to a recent report by Citigroup.
That same report also gave some interesting numbers regarding the asset classes now being sold through ETF’s. Only 6 years ago, equities represented 97% of the underlying of ETF’s! Only six years later, that has already started to change with fixed income now representing 6%, commodities 11% and FX 4%. That is a major change and in many ways a sign of things to come in my opinion. For most investors, ETF’s represent the easiest and cheapest way to gain exposure in a variety of different sectors or asset classes. Investing in currencies or commodities was done by pension funds or hedge funds only a few years ago but it is now just as easy to do so for individual investors.
It might not be 100%, but a very large majority of individuals and professionals believe that diversification represents an important way to gain the same return but with less downside risk. 20 years ago that meant buying bonds, private investments, etc. The major problem with that strategy is illiquid investments are often very expensive if you are not pouring a major amount of capital. A prime example is looking at the prices of a bond when you are buying $50,000 worth. It is understandable of course that sellers will give better prices to buyers of millions of dollars as it is an easier trade for them. Take a few percentage points here and there and you will see just how much of an impact it can have over a life of savings and investing.
In many ways, ETF’s provide a viable alternative as they offer the opportunity to get broad (corporate bonds) or specific (1-3 year treasuries) positions that will not cost you much in terms of commission. Furthermore, ETF’s will get you much better pricing and potentially much improved returns over the long term.
Because of that, I believe that in most cases, investors can keep over 90% of their portfolios in ETF’s. Of course, the more money you have to manage, the greater the possibilities which at that point, ETF’s might not represent as much of a bargain. But until I have $1 million looking for a good investment, ETF’s will be just fine for my needs.
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