NEW YORK (MainStreet) — Exchange-traded funds, or ETFs, are becoming more popular as investors are drawn to their lower fees and as more options are being offered.
ETFs have been around since 1993, but their popularity has soared in the past few years as more company 401(k) plans are offering them as an option. The total amount of funds in ETFs totaled $200 billion about ten years ago and investors could only chose from a few dozen options, said Wayne Connors, chief portfolio manager of 401k Investor, a Hartford, Conn. company which allows investors to build their own portfolio using ETFs within their existing retirement accounts. Assets in ETFs now exceed $1.7 trillion, and there are over 1,500 ETFs for investors to choose from.
ETFs are an "advantageous way" to invest for retirement since the fees are much lower than traditional mutual funds and trade like a stock by tracking an index, a commodity or a group of assets, he said.
The annual expense ratios for ETFs are consistently lower compared to mutual funds in the same investment category. The money saved by 401(k) participants from lower investment fees can translate into a substantial increase in retirement income.
"Employees can lose up to $200,000 in their retirement account over their working career due to hidden fees they may not even be aware of," Connors said.
More employers are now offering ETFs as investment options within company 401(k) plans, and some companies such as Apple have chosen ETFs to be the only choice within their 401(k) plan.
Since the onset of the 2008-09 financial crisis, more demand for financial transparency has been sought. ETFs disclose their portfolio holdings on a daily basis, making it easy to quickly identify underlying holdings. On the other hand, mutual funds only disclose their holdings quarterly or semi-annually.
ETFs can provide more diversification for investors compared to mutual funds. An ETF allows investors to gain access to asset classes that offer diversification benefits that mutual funds can't offer like international small-cap stocks and global real estate, he said.
"Unfortunately, most of these areas are not included in the typical mutual fund 401(k) plan, which makes the plan deficient in the area of diversification," Connors said.
ETFs could also provide better investment returns since the majority of them are linked to market indexes, "which have historically outperformed Wall Street's money managers," he said.
Smart beta ETFs, which offer a new angle in how they are weighted, have also been gaining in popularity, said Brock Moseley, managing director of Miracle Mile Advisors, a Los Angeles-based investment firm.
"They have really taken off and are also known as intelligent index ETFs or factor based ETFs," he said. "With $65.1 billion of inflow of funding, 2013 saw record inflows into smart beta ETFs.
Dividend weighted funds were a big reason for this. To put this in perspective, in 2013, the total amount of ETF inflows were $247.3 billion, so smart beta products made up one fourth of them."
Investors have also shown a "tremendous amount of interest in senior loans or leveraged loans," said Moseley.
"People are attracted to these because of the minimal interest rate risk and because bank loans act like floating rate notes since the rates are reset every month or two," he said. "Default rates are very low, but we must not forget if there is a recession or some other type of liquidity crunch, senior loans can get hit hard."
High-yield ETFs have also garnered a lot of interest and the booming oil and gas industry in North America has resulted in interest of energy ETFs as well as ones that focus more on energy infrastructure such as pipelines, MLPs and natural gas storage, Moseley said.
"We are seeing massive inflows into very short-term bond funds," he said. "This has encouraged a number of new ETFs in this space. BKLN and HYS are great examples."
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Commodity ETFs are also making a comeback, Moseley said.
"After a brutal 2013, we are starting to see people moving back into this area," he said. "We are looking specifically at agricultural commodities due to extreme weather conditions affecting crops."
JJA is an example, he said.
ETFs are a "better vehicle to allocate your assets," he added. Moseley recommends that investors reallocate their portfolios by divesting all of their mutual funds and transferring their assets to ETFs.
"ETFs are increasing in volume while mutual funds are decreasing in size," he said. "They are a smarter way to invest your money by keeping your fees and tax consequences low."
The average mutual fund fee is 1.39% compared to just 0.21% for ETFs, Moseley said.
"Research indicates that mutual funds rarely outperform their benchmark and charge higher fees for identical performance," he said." Using ETFs can save you 1.2% off fees alone."
--Written by Ellen Chang for MainStreet
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