Turnover Rates of ETFs

“Turnover Rate” is the percentage of the portfolio’s holdings that have changed over the span of one year. In other words; this number represents the level of trading activity. The turnover rate has an effect on all types of funds including ETFs. A higher turnover rate can lead to more trading costs and more capital gains distributed to shareholders (which they must pay taxes on). Turnover rates of ETFs are extremely low, because they are index funds and simply duplicate the index they are benchmarked to. Most of the turnover occurring within an index is due to mergers & acquisitions. The average turnover rate of an S&P 500 ETF is about 5%. On the other hand, an actively managed mutual fund has an average turnover rate of about 85%. Hmmm... makes you think doesn't it...

ETF Expense Ratios

Although all Exchange Traded Funds (ETF) are index funds, they still incur administrative / management / operating costs. All of these costs make up what we call the “expense ratio” of the Exchange Traded Fund (ETF). Unfortunately, “expense ratios” affect your rate of return. Let’s just say your ETF has an expense ratio of 0.50%. Therefore, if your ETF has a one year return of 10%, you don’t actually get to keep that 10 percent. After the ETF Company subtracts the 0.50% expense ratio, your return will be 9.50%.

Don’t be discouraged by this; ETFs have the lowest expense ratio of any type of fund. The average expense ratio of a U.S. Equity ETF is a mere 0.39%. The average for a Traditional Actively Managed U.S. Equity Fund is 1.48%. That is a huge difference, especially considering that index funds have outperformed 85% of all managed mutual funds over many years.

Just for your information, International ETFs have an average expense ratio of 0.68% (Traditional Actively Managed International Funds: 1.75%). Fixed Income ETFs have an average expense ratio of 0.17% (Traditional Actively Managed Taxable Fixed Income Fund: 1.13%). The cheapest ETF available is the iShares S&P 500 Index (IVV), which has an expense ratio of only 0.09%. On the other end of the spectrum; the most expensive ETF to my knowledge is the iShares Taiwan Index (EWT) with an expense ratio of about 1.03%. The Vanguard family of ETFs has the lowest average expense ratios at only 0.22%.

Conclusion:

ETFs are a significantly lower cost investment than Traditional Actively Managed Funds, not taking into account taxes and brokerage commissions.

STOCK PICKING IS A LOSING STRATEGY

Here is a great article about stock picking and indexing that I have recently found (click on the link to read entire article):

Title of Article: Is Stock Picking Declining Around the WorldThis article argues that there is a move towards indexing. This article is objective and credible.

Some interesting data from "Is Stock Picking Declining Around the World"

• "There is more stock picking in emerging markets than in developed countries"
• Despite the above observation, stock picking is declining everywhere.
  
• Stock picking in U.S. has gone from 60% in the 1960s to 24% in the 2000s.
• The author concluded (based on a theoetical model) that stock picking will eventually settle at 11% of trading volume in the U.S.
  

Young and looking to invest...well, time is on your side

One thing I noticed in High School and College was the lack of financial education. Many fellow business students at my college didn't have a clue about investing. Those that claimed they were stock market experts, thought they had "crystal ball" predicting abilities which as we all know; spells disaster. Index Mutual Funds and Exchange Traded Funds are a great way for young people to start investing, especially considering their (often) lack of financial education and inexperience. If you are young, time is on your side, start today, and the power of compounding and diversification of index funds will astound you. Be a savvy investor; minimize your risk and maximize your reward.

First Fundamentally Weighted ETFs

Most Exchange Traded Funds (ETFs) are benchmarked to market cap-weighted indexes. In fact, most of my portfolio is comprised of these. Recently, a company called WisdomTree became the first family of Fundamentally weighted funds. The weights of each holding in these funds are not just determined by the market-cap of the company, but instead the fundamental values of each security. It will be interesting to see if the performance of these ETFs can negate the efficient-market theory