Cut Your Costs With ETFs

9/17/2012


Total assets in exchange-traded funds (ETFs) hit $1.23 trillion in August, up 16% since the start of the year and nearly double the level of three years ago. The funds, which offer greater trading flexibility and transparency than traditional open-end funds, have won over investors largely because of their low costs.


Average fund expenses

Category
ETF
(%)
Mutual
Fund
(%)
U.S. Stock
0.46
1.43
Int'l Stock
0.51
1.52
Emerging Mkt. Stocks
0.63
1.75
Interm.-Term Bond
0.23
1.03
Short-Term Bond
0.20
0.93
Municipal Bond
0.32
1.06

Most ETFs mirror an index, which is inherently less expensive than managing an active portfolio. The average U.S. stock ETF charges an annual expense ratio of 0.46%, versus 1.43% for domestic stock mutual funds.

You can find low-cost ETFs in nearly every corner of the market, as about 640 of the more than 1,470 funds have expense ratios of 0.50% or lower. More than 170 charge 0.20% or less. Vanguard offers 19 ETFs with expense ratios below 0.12%, including Vanguard S&P 500 ($66; VOO), with a fee of 0.05%.

While low-cost ETFs abound, cost alone doesn't make them good buys. We have identified 15 ETFs with both below-average expense ratios and solid track records — all but one fund has outperformed its peer group over the past year. Notably, components of the seven U.S. stock ETFs earn weighted-average Quadrix Overall scores of at least 56, with a solid average score of 61. Moreover, all seven have a meaningful portion of assets in stocks with Overall scores above 80 and little in stocks with scores below 20.

SELECT EXCHANGE-TRADED FUNDS
% Of All-ETF
----- Portfolio -----
ETF (Price; Ticker)
Conser-
vative
(%)
Growth
(%)
Expense
Ratio
(%)
Category
Guggenheim S&P Smallcap 600
($57; RZG)
10
10
0.35
Small-cap growth
iShares Morningstar Small Value
($90; JKL)
7
8
0.30
Small-cap value
iShares MSCI EAFE Small Cap
($38; SCZ)
5
5
0.40
Foreign small-cap
iShares S&P Growth Allocation
($34; AOR)
6
9
0.31
Balanced
iShares S&P MidCap 400 Growth
($114; IJK)
6
7
0.25
Midcap growth
iShares S&P MidCap 400 Value
($86; IJJ)
5
6
0.27
Midcap value
SPDR Barclays High Yield Bond
($40; JNK)
5
5
0.40
High-yield bond
Vanguard High Dividend Yield
($50; VYM)
12
12
0.13
Large-cap income
Vanguard Inter.-Term Bond ($90; BIV)
9
0
0.11
Inter.-term bonds
Vanguard Mega Cap 300 Growth
($57; MGK)
12
12
0.12
Large-cap growth
Vanguard Mortgage-Backed
($53; VMBS)
5
4
0.15
Ginnie Mae bonds
Vanguard MSCI EAFE ($34; VEA)
5
4
0.12
Foreign large blend
Vanguard MSCI Emerging Mkt.
($41; VWO)
0
4
0.20
Emerging market
Vanguard S&P 500 ($66; VOO)
6
7
0.05
Large-cap blend
WisdomTree DEFA ($44; DWM)
7
7
0.48
Foreign large value

We used the 15 ETFs to create two model portfolios that should appeal to cost-conscious index investors. The ETFs mimic the general attributes of our recommended mutual funds, and their suggested weights correspond to the target weights of our Growth and Conservative portfolios.

The all-ETF portfolios have annual expense ratios of no more than 0.25%, though ETF trades typically incur brokerage commissions. Based on trailing 12-month distributions, we estimate the all-ETF Conservative Portfolio yields 2.4% and the Growth Portfolio 2.2%, aided by a position in SPDR Barclays High Yield Bond ($40; JNK), yielding roughly 7.1%.

OUR RECOMMENDED MUTUAL FUNDS
-- Year-To-Date --
--- % Of Portfolio ---
 
Fund (Price; Ticker)
Return
(%)
Rank
Conser-
vative
(%)
Growth
(%)
Fund
Rating
Dreyfus Midcap Index ($30; PESPX)
14.6
B
0
0
77
Dreyfus Small Cap Stock Index
($23; DISSX)
15.0
B
0
0
95
Fidelity High Income ($9; SPHIX)
11.7
B
5
5
96
Homestead Small Company
($26; HSCSX)
15.3
A
7
8
100
Manning & Napier International
($8; EXITX)
8.7
E
7
7
61
T. Rowe Price New Horizons
($37; PRNHX)
17.6
A
10
10
100
Vanguard 500 Index ($133; VFINX)
15.6
B
6
7
81
Vanguard Dividend Growth
($17; VDIGX)
10.3
E
12
12
99
Vanguard Emerg. Mkts. Stock Indx.
($26; VEIEX)
8.4
C
0
4
73
Vanguard GNMA ($11; VFIIX)
2.2
C
5
4
86
Vanguard Growth Index
($37; VIGRX)
17.7
B
12
12
98
Vanguard Inter.-Term Tax-Exempt
($14; VWITX)
4.4
B
0
0
69
Vanguard Selected Value ($21; VASVX)
11.9
C
5
6
84
Vanguard Short-Term Invest.-Grade
($11; VFSTX)
3.5
B
0
0
89
Vanguard Total Bond Mkt. Index
($11; VBMFX)
3.3
E
9
0
40
Vanguard Total Int'l Stock Index
($14; VGTSX)
10.3
C
5
4
64
Vanguard Wellesley Income
($24; VWINX)
8.4
C
0
0
100
Vanguard Wellington ($34; VWELX)
10.7
C
6
9
91
Wasatch International Growth
($22; WAIGX)
22.1
A
5
5
100
Wells Fargo Advantage Discovery
($27; STDIX)
16.6
A
6
7
93
* Year-to-date ranks through Sept. 11 from Morningstar, comparing performance among funds with same objectives. A = top 20%; B = next 20%; C= middle 20%; D = next 20%;
E = bottom 20%. Fund ratings are percentile ranks based on our fund-rating system.

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