ETF

There are a few reasons to choose one or the other. Let's freeze the concept to S&P 500 for one minute. ETFs have low expense, no cap gain distributions, but (maybe) high transaction fee, e.g. a $5 commission is crazy for weekly $100 purchases. The mutual fund has expenses (may be more or less than ETF) risk of cap gain distribution (not applicable so much within tax-deffered account) but low min buys and (I hope) no transaction fee.

Back to general - no issue at all mixing from both so long as you do your homework. Don't think an ETF and Fund with same objective will always perform identically, and for Pete's sake don't treat having one from each be considered different from a diversification standpoint. There are tools that will help you discover overlap for ETFs/Funds that are tied to different indexes but share some stocks.

Off my podium, what are your concerns having both types of product? /Joe

Thanks Joe. I have never looked into ETF's before and really did not know that much about them other than just the basics. It sounds like they act prety much like a mutual fund. Fidelity charges $7 or so for a brokerage transaction but they have

30 ETF's that are free and most of them appear to be index types. Any assett class where I don't like the Fidelity fund or they don't have an index fund for, I'll look at the ETF next and see what they have.

Thanks David K.

Those are pretty amazing in having no commissions. Quite good quality and diversity, although not every type of asset class is covered and you may want to substitute mutual funds or other commissioned etfs at times. In fact even for a covered asset class, you might want to consider an alternative based on consistantly better past performance.

Of course you can examine performance within the fidelity web site. But since that can be tedious as a few at a time, I have a quick and dirty comparison already cooked up, where you can get the gist and change timeframes or overtype other securities to compare. This does not show the benefit of dividends. A lot of them are highly correlated to each other:

30? Phew, that puts my charts out of date. Their 5 new ones are pretty interesting. I cram them into my last chart here below, although it makes it a mess combining bond and equity funds. At least it keeps SOME list handy; it appears fidelity is coy and only provides the freebie list after tedious navigation to a page that doesn't reveal it's internet address...

Thanks for the links. Right now I'm mainly looking at ETF's to fill in the asset gaps that I think Fidelity is lacking like emerging markets(EEM) and intl small cap(SCZ). The mutual funds they do have for those classes have a high expense ratio and so-so returns. The other main classes they have index funds for and I will probably go that route. I looked at some of the other i-Shares ETF's and other than comparing expense ratios and the return numbers, I can't tell why an index ETF would be better or worse than its corresponding index mutual fund. Any advice on this would be appreciated.

Thanks David K.

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Two issues to keep an eye on are tracking error (difference between the return of the ETF and the index it's based on) and discount/premium. Both can be researched on the ETF providers' websites. The less broad/liquid the asset class, the more likely you'll find something.

Some of the ETFs have been disconnected from index returns at times, by percentages much more substantial than their cost differences. And one thing in favor of traditional open-ended mutual funds is that they by law trade at NAV (net asset value) - $1 buys $1 in assets. ETFs can be very close to that, but also, they can drift noticeably at times. This drift is both a way to make and lose money, vs. buying the open-ended mutual fund. But obviously, if an ETF has say a 0.05% per year cost advantage it'll take a long time to make up a 2% premium to NAV paid at purchase - who cares if the trade is free.

Hint: whatever asset class people are freaked out about at the moment, whether positive or negative, have a look at the discount/premium in the ETFs in that asset class. Those are times that it's more likely to be enough to consider as part of the decision (though still, it might not be a factor at all - it's something to look at on your buy date).

Oh - third issue - trading spreads. Some of the daily trade charts look like sawtooths. Buy high, sell low and the difference is the spread. If that spread is substantially bigger than your cost advantage, why buy the ETF?

-Tad

For me, ETFs have the top preference. These can be volatile times, and you can easily and needlessly lose a thousand bucks by the delay from your trade order time to the end of day strike price for the mutual fund. With etfs, you can know pretty close what you will pay for it and can decide accordingly. Most of the fidelity etfs have small spreads, and even if wide you often land near the middle. An exception is if you throw in an order before opening time - I could tell you war stories about that (put in a high buy limit and they will take every penny).

Also mutual fund expenses can be high - I recall the good old days when etrade would often rebate you about half of this, and could lead to hundreds of dollars per year. Sure, many are lower now, but mainstream etfs are reliably low and I think even the esoteric premiums and tracking errors can be pretty much ignored for the fidelity freebies. The main drawbacks of etfs are gone with these, where incremental topping off would cause you repeated commissions.

Still, I think you still have to pay a small SEC charge per share trade, so don't get too clever and put in a limit order that would zero out your cash balance. Also I was surprised to find for commissioned etfs, fidelity can charge you multiple commissions for one order if part of it happens to execute on another day. Before a trade, it helps to click on the ticker number to bring up a fidelity quote box and click refresh a few tiimes. Can see where the trade prices are falling between the spread, and whether there is upward or downward momentum (so either hurry or pause).

Thanks Tad. That too was a lot of information; most of it I really didn't understand until I looked up some of the terms. I did notice their tracking errors seemed kinda high to me at 5.55% and 8.91% but I'm not sure if their spread and discount/premium numbers are good or bad.

Thanks David K.

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As an example - if you go to the iShares site you can pull up a chart of historical discount/premium ranges for all of their ETFs. I just looked at SCZ and in the quarter Apr-Jun 2010 the biggest premium was +2.06% and the greatest discount was -2.31%. You can see how this could either work for or against you. A nice combo would have been buying at a discount, selling at a premium, and then going to the open-ended mutual fund with your free money! It's essential to know what the situation is when you're buying or selling (and possibly, to use limit orders to avoid getting your clock cleaned on the trading spread).

The tracking error is more subtle because it can be affected by the timing of money coming into or leaving an ETF and the fact that they are traded intra-day, including at times when these international markets are actually closed. The ETFs that hold easily-traded large-cap US stocks tend to have much less of an issue, but emerging market and international small-caps stocks are quite a bit different. So are municipal bonds, junk bonds, microcaps, sector funds...basically the funkier the asset class the more homework you should do on the ETF because the expense ratio isn't going to tell the whole story.

-Tad

Or gain a thousand bucks, right? Over time it should be a wash, with some trades better and some trades worse.

-Tad

Thanks Tad. I think I'll stick to mutual funds until I get a better idea of how ETF's work.

David K.

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Just my opinion but I think this is not the correct response to Tad's information. Vanguard (and possibly now Fidelity) offer very low expense ratios for their ETFs. If these expense ratios beat the equivalent mutual fund for a particular category of stocks/bonds, I would buy the ETF and sleep fine at night.

Ditto. Tad brought up a point which is not across the board. There are ETFs whose tracking error is virtually nil. There's a world of difference between an S&P ETF (and differences even among those) vs the incomprehensible triple leveraged inverse ETFs. That's not to dismiss Tad's point. It's just far more relevant as you get away from well defined, well publicized indexes and more toward those I allude to. To add to his approach - the ETF he cited as an example was for a small cap index. The index itself is easy to understand as it would have X stocks and a simple bit of math to go from stock price to index. But when an index contains thousands of stocks, its ETF typically takes a subset and hopes that subset's correlation to the entire index is high enough. On the other hand a DIA (dow 30) contains 30 stocks. I can (I mean me, literally) buy the right number of each share and have an account that tracks the index 100%. This observation is in addition to Tad's remarks on buy/sell within the ETF to support liquidity needs. That's true as well. But also true for Mutual funds. As is the tracking errors we discussed.

I wrote about an inverse leveraged ETF and its tracking issues in the cleverly titled "ETF'ed"

I meant I'll look into ETFs and how to read the numbers a little more closely before just buying into one.

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Joe, Elle - look up-thread, David is looking at ETFs for emerging markets and international small-cap stocks, not say VTI. Hence my reply...

-Tad

See Vanguard's VWO and VSS.

Nothing is wrong with your reply.