Is ETF Tradability Good or Bad?

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  1

  MrRosemary

  08/10/09 | Report as spam

  RE: Is ETF Tradability Good or Bad?

  The liquidity of ETFs can be a detriment to investors, but there's some other aspects that are often forgotten. Because ETFs are so liquid, and because shares can be created and redeemed daily, they require a very precise transparency -- otherwise there would be no way to create ETF shares since nobody would know exactly what was needed to go into them.
  
  It is this transparency that greatly benefits individual investors. Unlike a mutual fund, whose composition is only revealed quarterly (and even then months after the quarter's end), I know exactly what I am getting moment by moment when buying an ETF.
  
  I know its underlying index, I know the composition of equities or bonds, and in what amount. And I know this instantaneously. There are no surprises.
  
  The process for buying a mutual fund is akin to ordering food at an Indian restaurant with no menu, and no prices. You simply walk in and the server says, "We serve Indian food. We will serve up to 85% of our food as Indian food. The remainder 15% can be food of any country around the world that the chef has determined to be delicious. We also have the right to serve no food, instead serving non-edible products related to food. There is no assurance that these goals can be met."
  
  Ok, you say, how much does a meal cost? The server continues, "We calculate the cost after you have placed your order and paid for your food. You give us as much money as you wish, and we serve you as much food as that money buys. Exact change only."
  
  That same experience, only with an ETF, would go like this.
  "I want the Rogan Josh, 3 slices of naan, a lassi. How much?"
  
  $14 per order.
  
  "Great. I'll take 3 orders for $42."
  
  You know what you are getting, how much it costs, and know this data every second of the day that the market is open. That to me is the biggest advantage to ETFs. Transparency.

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  2

  larry swedroe

  08/11/09 | Report as spam

  RE: Is ETF Tradability Good or Bad?

  Mr Rosemary
  All those benefits you point out of ETFs are also present in index funds, or the structured portfolios of Dimensional Fund Advisors. You don't need to be an ETF to have transparency, you just need to avoid active funds!!
  
  Now ETFs can provide the possible advantage of tax efficiency over a regular index fund. But that can be overcome by using tax managed funds and also by using what Dimensional Fund Advisors calls "core" strategies which combine multi asset class funds into one fund, reducing the need for trading as stocks migrate from one asset class to another and also reducing the need to rebalance between asset classes. And those funds don't have the "disadvantage" of being able to trade during the day (some people cannot resist the temptation)

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  3

  MrRosemary

  08/12/09 | Report as spam

  RE: Is ETF Tradability Good or Bad?

  I agree with you that DFA funds are among the best in class, but I don't like the difficulty of investing with them. There's this arrogance like, "You're too dumb to be trusted to manage your money. We require you to hire someone to do it." For this reason, I'm much more inclined to lean towards Vanguard despite not having the same performance.
  
  I'm too much of a libertarian to think that way. Give the people the advice, but let them have the freedom to make stupid decisions with money. Sometimes that's the best purchase someone can make.
  
  Plus, most DFA advisors have at least a $50,000 requirement. Most >$100,000. While that's a small amount given the needs to retire, it's a tremendous amount for someone who has not been investing for a decade or more with an average income.
  
  I like DFA funds, and their philosophy about the funds structure. But when it comes to their business model, it smacks of ivory tower arrogance.

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  4

  larry swedroe

  08/13/09 | Report as spam

  RE: Is ETF Tradability Good or Bad?

  Mr. Rosemary
  DFA's business model is entirely different than Vanguard's. By not working directly with the public they have much lower costs to run the firm. They don't need 800 numbers manned by huge staff's, they don't have to open and close accounts, they don't have to send monthly statements, etc. They run a company with about $150b in assets with only about 300 people or so. And the people who own the company like that. If their funds were available to the public they would be more expensive.
  
  They also believe, and I am in total agreement because it is supported by the evidence, that the vast majority of individual investors acting alone simply do not have the discipline to be buy-and-hold and rebalance investors. You personally might be, but then you are the exception. Thus, the turnover created by the noise of the markets that they engage in imposes costs on the remaining shareholders and in taxable accounts it imposes taxes. They chose to address this problem by requiring the use of an advisor who commits to DFA that they will keep their clients disciplined.
  
  
  Note however that DFA funds are available to the public in many 401k plans--my own company has helped over 500 companies set them up and run them---and 529 plans.
  
  Vanguard funds and ETFs are good alternatives but in my opinion the new CORE funds that DFA has introduced is the leading technology in investing. And not using them because you might not agree with their business strategy would be the equivalent of "biting you nose to spite your face." You should use the funds that provide you the greatest likelihood of achieving your goals.
  
  As to advisors, that is a separate issue. An advisor should be able to show you how they add value through things like:
  a) developing a well-thought-out investment plan that gives you the best chance of achieving your goals without exceeding your ability, willingness and need to take risk--and considers a "Plan B" -the actions to be taken if risks show up that are greater than anticipated. The use of an MC simulator I believe is an important tool to help with that process. I wrote a blog post on this topic.
  b) integrates that investment plan into a well-thought-out estate, tax and risk management (insurance of all types). We now even help people with their property and casualty insurance to make sure they have the best policies, with the fewest gaps in coverage at the most efficient cost.
  c) provides the discipline of risk based (not time based) rebalancing and tax loss harvesting throughout the year (not just at year end when it can be too late).
  d) helps with all other financially related issues like mortgages, debt repayment, etc.
  e) educates investors and their children on the academic evidence so that they understand the strategy, regularly communicating with them, especially during bear markets when discipline is tested.
  f) makes sure they use the state of the art vehicles to implement the strategy.
  
  And there are many other ways a good advisor adds value. And it should not be to simply provide access to DFA funds.
  
  I hope that is helpful
  
  

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  nrlincoln

  09/03/09 | Report as spam

  RE: Is ETF Tradability Good or Bad?

  Great piece, which dovetails in with a blog I published recently on the subject of ETFs and their ability to be so easily traded.
  
  http://v2vfp.blogspot.com/
  
  In the blog i refer to Larry's piece, so thanks!