"History does not repeat itself, but it does rhyme." Mark Twain (1835-1910)
A study as reported in The Wall Street Journal(WSJ)'s May 7, 2007 issue, answers the question, "Do ETFs produce better returns for small investors than regular index funds?" The answer may surprise you...
There is no doubt that Exchange Traded Funds (ETFs) are extremely popular. WSJ states that total assets have more than doubled to some $450 billion in less than three years! ETFs covering every corner of the market are popping up every day in "exotic" and risky areas such as commodities. As with many trends, the beginning of the end is marked by irrational behavior. While ETFs are not necessarily a "trend," the velocity and prevalance of new exotic products, absent prudent education, certainly is.
In my previous post addressing Index Funds vs. ETF's, I underscored the logic of leveraging the "passive" nature of the funds in support of the Efficient Markets Hypothesis (EMH). Check out the post for more detail, but, essentially, I stated that Index Funds and ETFs are best used in the most "efficient" areas of the stock market, such as large-cap stocks.
Now back to the question of which is better in terms of performance...
The conclusion of the study found in the WSJ article was that big, low-cost index funds from Fidelity Investments and Vanguard Group, outperformed the ETFs in 34 of 40 time periods analyzed, including a complete sweep for one, three, and 10-year after-tax categories.
You may recall that I cautioned the use of "thinly traded" ETF's because of the cost of "the spread." By deductive reasoning and by following my philosophical logic in the first Index Funds vs. ETFs post, a "philosopher" would lean toward an Index Fund over the ETF: Since we are logically applying the greatest power of passively managed funds (reducing the fund expenses and removing the manager risk of actively managed funds), and applying it to the area where their use is most likely to succeed (large-cap stocks), then the big name, large cap Index Funds (Fidelity Spartan 500, Vanguard 500 Index) are winning the race. What's more, without a significant track record, who's to say if ETFs can or cannot surpass Index Funds for performance in the future? Since history is all we have for reference and we know that "history rhymes" then my bet, as a logical-thinking creature, will remain with our old, reliable friend, the Index Fund...
TFPAuthor, Kent Thune, is the President and Owner of Atlantic Capital Investments, LLC (ACI), a fee-only, registered investment adviser based in Mount Pleasant, SC, near Charleston. ACI specializes in retirement, investments, and comprehensive financial planning.
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