Using Exchange-Traded Funds

[JLP]

Are any of you using exchange-traded funds (ETF) to meet your portfolio needs?

I have been studying ETFs and as soon as I figure out how to insert a table, I'll post my results.

JLP

http://AllThingsFinancial.blogspot.com

[brewer12345]

Yes, I helped my MIL set up her retirement portfolio using mostly ETFs. As I gradually farm out asset classes I don't want to actively manage myself (intl bonds and equity, large caps), I will be making use of ETFs rather than funds.

[JLP]

Geez! *This took me freakin' forever to get into this format! *Anyway, here are the 2004 results of what I feel is a retirement-worthy portfolio consisting of 40% US Equities, 40% US Bonds, and 20% International Equities.

12/31/2003

12/31/2004

Value

Value*

iShares DJ US Basic Materials IYM

$40,000

$44,835

iShares DJ US Consumer, Cyclical IYC

$40,000

$44,283

iShares DJ US Consumer, Non-cyclical IYK

$40,000

$44,759

iShares DJ US Energy IYE

$40,000

$52,626

iShares DJ US Financial Services IYF

$40,000

$45,158

iShares DJ US Healthcare IYH

$40,000

$41,678

iShares DJ US Industrial IYJ

$40,000

$46,508

iShares DJ US Technology IYW

$40,000

$40,534

iShares DJ US Telecom IYZ

$40,000

$47,225

iShares DJ US Utilities IDU

$40,000

$49,066

iShares MSCI EAFE EFA

$200,000

$237,840

iShares Lehman Aggregate Bond AGG

$200,000

$207,413

iShares GS $ InvestTop Corp Bond LQD

$200,000

$211,131

$1,000,000

$1,113,057

*Means dividends are included.

JLP

http://AllThingsFinancial.blogspot.com

[brewer12345]

Too much trouble, IMO. It would be a lot easier to have a single bond ETF, like AGG, a single intl equity ETF, and perhaps one or two domestic equity ETFs, such as an extended market index and a small cap ETF.

[JLP]

Quote:

Too much trouble, IMO. *It would be a lot easier to have a single bond ETF, like AGG, a single intl equity ETF, and perhaps one or two domestic equity ETFs, such as an extended market index and a small cap ETF.

Well, the reason I included all ten sectors of the Dow Jones Total Market Index is that I have found by buying the Total Market Index in this way and rebalancing once a year, you can improve your returns.

I don't think it is too much work. You just have to rebalance once a year.

JLP

http://AllThingsFinancial.blogspot.com

[Hyperborea]

Quote:

Well, the reason I included all ten sectors of the Dow Jones Total Market Index is that I have found by buying the Total Market Index in this way and rebalancing once a year, you can improve your returns.

Hmmm, what if we compared this complicated portfolio to a simpler one using the world market cap weighted portfolio suggested by Prof. Sharpe and keeping the same equity bond ratio as JLP's portfolio? *Which one fared better? *
31-Dec-0331-Dec-04
VTI40%104.67118.05
EAFE50%134.71160.25
EEM10%161.95201.85
Equity Value60%125.418147.53
Bonds - AGG40%98.67102.4
Portfolio Value114.7188129.478
Percentage Gain12.87%
JLP's Percentage Gain11.31%

[JLP]

Interesting. *However, 36% allocated to international seems kind of high for a retired person.

JLP

[Hyperborea]

Quote:

Interesting. *However, 36% allocated to international seems kind of high for a retired person.

40% of equities in US stocks is currently the way that the world values the US market as a percentage of the world market. *If one "believes" in any level of market efficiency at all then this makes sense as a portfolio allocation amount. *If one believes the behavioural market researchers that markets can become irrational based on emotional reactions of investors then perhaps the US market is over represented at 40% and a smart investor should have even less there.

For myself, in retirement I will have a bit more diversified portfolio than that but in diversification that makes more of a difference rather than holding more Dow Jones sectors.

[JLP]

A 1% difference in return is significant in my book. From 1992 - 2004 the Dow Jones Total Market Index had an average annual rate of return of 10.24% ($100,000 would have grown to $355,000). Holding the 10 sectors individually and rebalancing them annually had an average annual rate of return of 11.28% ($100,000 would have grown to $401,000) over the same time period.

I have an excel spreadsheet of my analysis if you want it. Just let me know.

JLP

http://AllThingsFinancial.blogspot.com

[unclemick]

Being a Boglehead(pretty much).

Two things: Any improvement to the investor is priceless - in the accumulation phase. And two, the 'real investor' has to actually capture those returns after expenses and taxes.

To quote Clint Eastwood: "A man's got to know his limitations."

Nimble and emotionless disciplined rebalancing? ----Hmmm - chickenheartedness prompts me to let the Vanguard computers do it for me. I had twenty years or so of trying it myself(call me blockheaded) before throwing in the towel.

I take my hat off to those who can - AND keep expenses down.

[dex]

I have to agree with Unclemick2 on this one.
How many people can allocate funds, time the market (rebalance) to get that 1% advantage? Very few I would say.
Hindesite is great.
Here are the question: What do you put you $ into now. When do you rebalance. What do you put it into when you do reblance?

[JLP]

I guess that is a decision you have to make for yourself. Of course, you do have to fight the emotional battle (but aren't you fighting that same battle by being in the market?).

But, I think deciding on an allocation and sticking to it by rebalancing once per year (usually in December) is a good way to combat those emotions.

JLP

http://AllThingsFinancial.blogspot.com

[charlie]

The idea of rebalancing is to buy low, sell high ....
no market timing needed if you do it regularly.

Unclemick has it right for 99% of persons in the
accumulation phase. For myself, in RMD phase, I
am using slice and dice in order to avoid reverse
DCA. If/when I grow weary, everything goes into
Wellesley or TR Income.

Cheers,

Charlie

JLP
If ETS's are purchased from a broker does the broker continue to get commissions after the original purchase.
What is the yearly cost factor after purchase.
Are they all about the same?
What do you think of the Nuveen ETF's
Regards,
JOE

[Hyperborea]

Quote:

If ETS's are purchased from a broker does the broker continue to get commissions after the original purchase.

A broker gets a fee only on the purchase just like purchasing any other stock. *This can be a downside if you are comparing ETFs versus low cost mutual funds (e.g. Vanguard) since there is no fee to purchase many of these low cost mutual funds. *You need to make your purchases of ETFs at a level that keeps your trading costs low. *If you buy into say 13 ETFs every month (perhaps made up of DJ ETFs plus bonds) and you pay $10 / trade that will run you $130 / month and $1300 / year. *Even if you are investing $130K per year that will cost you 1% of your gains.

Quote:

What is the yearly cost factor after purchase. Are they all about the same?

Every ETF has an expense ratio (ER) that is the cost to run the investments. *It is the same kind of thing as a mutual funds ER. *The ratios are generally similar for ETFs that track the same type of investment though there are some that are better.

Quote:

What do you think of the Nuveen ETF's Regards, JOE

Haven't looked at them before as I don't use ETFs for the fixed income portion of my portfolio. *In a quick look though their ERs seem excessive and of the funds that I looked at (e.g. NUV) it trails their category. *In bonds it seems that the best indicator of performance (for the investor not the manager) is the ER.

[JLP]

Joe,

ETFs operate pretty much like regular stocks do. So, if you have an account at a discount broker, you only pay a fee when you make a transaction. As far as "full service"* brokers, they might charge you an annual fee if you are in a wrap account or if your money is being managed on a percentage basis.

I'm not familiar with Nuveen's ETFs. I'll check them out though.

JLP

*I love how they call themselves "full-service." I used to work for one, and I don't think they are anywhere near full-service.

http://AllThingsFinancial.blogspot.com

[Hyperborea]

Quote:

I have an excel spreadsheet of my analysis if you want it. *Just let me know.

10 years is nothing. There can be all sorts of "winning" portfolios over a single 10 year time frame that are absolute losers over the next 10. Also, after you factor in taxes and expenses many of these strategies turn out worse.

What really makes a difference for the rebalancing type strategies is the correlation coefficients. What are these for the DJ sectors? Not just for the last 10 years but as long as the data goes back.

[JLP]

I went back as far as my data would allow. Although I agree with you that a longer history is preferable, what I found interesting about my little study is how well it performed (and the index as a whole) even including the bubble years.

As far as history goes, it is still HISTORY. Nobody knows what we are going to face in the future. History has limited benefits. Therefore, one has to decide on a strategy that suits them (which it looks like you have done) and go for it.

As far as managing an ETF portfolio goes, one might look at a company like FOLIOfn that charges an annual amount with a certain number of trades allowed.

I agree with you that ETFs aren't for everybody. Accumulators may do better with index mutual funds if they are using a traditional brokerage firm.

JLP

http://AllThingsFinancial.blogspot.com

[Hyperborea]

Quote:

What do you think of the Nuveen ETF's Regards, JOE

Kathy-Joe,

Another point that I just noticed is that Nuveen ETFs are apparently closed-end ETFs. This is different from the well known ETFs such as SPY or QQQ which are open-end ETFs. What's the difference? It's pretty much as the name suggests. A closed-end ETF has only a limited number of shares created at one time (usually) and that is all that ever will exist. These are bought and sold on the market for whatever price people want to sell/buy them at. Now this may be for more or for less than the proportional value of the fund's assets that those shares control. This is known as a premium or a discount.

An open-end ETF allows new fund shares to be created through a pre-defined mechanism (generally trade in to the fund the right quantity of things - e.g. all S&P500 stocks to make a share of SPY). This mechanism usually requires a lot of capital to do so it is out of the reach of the individual investor. However, this mechanism limits the formation of premiums or discounts on the ETF. If it gets too large then institutional investors will take advantage of this to create or redeem ETF shares.

Neither is inherently "better" than the other though they do work differently and need to be treated differently. The open-end ETF works more like a traditional mutual fund.