Why pay somebody, for something you can do yourself? I was raised by this ‘slogan’. Why pay somebody to fill you gas, when you can do it for free? (jk, I’m not that old). Why pay a maid to do your laundry when you can do it for free? (jk I’m not that rich). Why pay somebody to shovel my driveway when you can move further south? (I mean do it for free). I’ve always wondered the same thing about mutual funds, why am I paying somebody to simply buy one share of each company in the S&P500?
How have mutual funds performed?
Mutual funds are created because of the belief that the experts know more than the common folk, and are therefore able to extract better gains and beat the general stock market. So is this in fact the case? Let’s take a look at the 90s, a great time for the American Stock Market. The greater stock market (Wilshire 5000) had a annualized 16.3% return, and the large caps (S&P500) outperformed that with an annualized 17.3%.
So I would expect the average mutual fund to have outperformed 17.3%, or at least 16.3%. But in fact the performance of these funds was 13.9%. That’s 3.4% LOWER THAN S&P500, and 2.4% LOWER THAN WILSHIRE 5000. Many of these mutual funds simply tried to match the general stock market index. So why the lower return? An annual expense ratio of 1.5% definitely didn’t help.
What is an ETF?
An exchange traded fund is actually very simple. In theory, it is simply a mutual fund that can be purchases through an exchange like the New York Stock Exchange. By outsourcing many of the customer facing interactions to these exchanges, the ‘mutual fund’ can significantly lower their expenses.
In addition, a vast majority of ETFs are ‘passive funds’. This means they don’t hire a number of high wager stock pickers that try to outperform the underlying Index (such as S&P500). Instead they simply purchase the appropriate ratio of each stock in the Index. Since this type of task can almost be automated, these ETFs can lower their expense ratio even further.
So how big is the difference? Remember we previously mentioned that the average actively managed mutual fund expense ratio is 1.5% per year. A passively managed mutual fund, about 0.5%. A passive Index ETF, only 0.25%.
Vanguard Emerging Markets ETF (NYSE:VWO):
The Thousandaire Portfolio has been looking for some diversification and international exposure in Emerging Markets for a while. VWO represents a low expense investment into the broader Emerging Markets. More importantly it requires minimal research from our part.
Although most of this post has been about ETFs, I feel I should quickly mention a few things about Emerging Markets. If you are not an overthrown middle eastern dictator, and now live in a hole, I’m sure you’ve seen a nonstop barrage of news stories and expert opinions about how Emerging Markets are expected to outperform developed nations over the next few years. Taking a quick look at the economic growth of varying nations shows developed economies ~2-3%, emerging market economies ~7-10%.
This economic growth will have a significant impact on the stock market growth in these developing countries. Therefore, the Thousandaire portfolio will look for continued investments in companies in emerging markets, or companies in developed countries that will profit from increased consumption in emerging markets.
There are a large number of ETFs out there today. Pick what area you would like to invest in, and I bet there is an ETF to match it. Fidelity (no association) even offers their top 25 ETFs with no trading fees.
The Hoff doesn’t own any and doesn’t plan on purchasing within the next 60 days. Kevin owns VWO.
The Hoff was having some trouble coming up with a stock pick this week, and I recommended he add one of my stocks to the Thousandaire portfolio. I really like VWO because it is a great way for me to get involved with emerging markets without doing endless research. VWO lets me invest in emerging markets and provides immediate diversification. I’m a big fan, especially since it is down 2.6% YTD.
Important to note that ALL ideas, thoughts, and/or forecasts expressed or implied herein are for informational and entertainment purposes only and should NOT be construed as a recommendation to invest, trade, or speculate in the markets.
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