Chapter 9 The Advantages of Exchange-Traded Funds

“ETFs, in their 25-year history, have become one of the fastest-growing segments of the investment management business.”

—Steven Schoenfeld

Up until the 1980s, implementing a low-cost diversified portfolio wasn’t easy. Many active funds were trying to beat an index rather than track it, and elsewhere active management, involving trying to pick stocks, seldom delivers repeatable, improved performance. However, the challenge of managing a portfolio yourself, when most benchmarks contain a few hundred to a few thousand instruments was both extremely expensive and extremely time consuming. Investors had two bad options.

The arrival of exchange-traded funds (ETFs) have improved the picture for small investors. They are a cross between stocks and mutual funds, but generally manage to offer the best of both worlds for the long-term investor. Since 1997, the assets devoted to ETFs has doubled roughly every four years, and ETFs now have approximately 10 percent of the assets of mutual funds,1 which have existed far longer. Actually, the growth in ETFs has coincided with strong growth in mutual fund assets, and the main reduction has been in direct holdings of equities. Essentially, investors are choosing to use funds to gain equity exposure, rather than holding individual company stocks. The growth in ETFs has been rapid in recent years, as Figure 9.1 shows.

Figure 9.1 ETF Asset Growth

Source: Investment Company Institute

The ...

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