newjerseynewsroom.com

BY WARREN BOROSON

NEWJERSEYNEWSROOM.COM

BOROSON ON MONEY

Nowadays investors are rushing to their advisers and eagerly saying, "I hear ETFs are great. Why don't you buy me some?" (Actually, these people tend to get it wrong...and say "EFTs.")

What their advisers tell them, of course, is: "What do you want INSIDE an exchange-traded fund? Exactly what do you want to buy?"

Then there are conferences on ETFs for beginners. And after an hour's worth of explanations, someone will almost inevitably ask a question like, "What's the difference between an exchange-traded fund and iShares?" (Answer: iShares are the leading brand of ETF.)

Still, ETFs amply deserve their exalted reputation today — as was emphasized on Tuesday at a press conference held in New York City under the auspices of Charles Schwab. A bunch of smart and well-informed people spoke on the subject, and while they lost me when they got to talking about stuff like "contangos," otherwise they made a lot of sense.

An ETF is a mutual fund that trades as a stock. Most are index funds. You can buy and sell them during the day, not just after the market closes. You can sell them short and set limit orders. They are also wonderfully tax-efficient, and low cost, to boot.

Some points the panelists at the press conference made:

One of the big advantages of an ETF is that you don't pay for the expenses that other investors incur. If another shareholder sells something and owes taxes, you don't have to pay a penny. It's as if you dine out with friends, and someone orders filet mignon and you order hamburger. You pay just for your cheap hamburger, not for the other guy's expensive filet mignon.

Buy an ETF from a reputable company — so there's less chance that your fund will be subject to (say) tracking error (the fund doesn't quite follow the index it's supposed to track).

Check the total cost — not just the expense ratio. Consider "implicit" costs, such as the cost of trading and market impact, along with the cost to rebalance a fund to its original exposure.

And check out an ETF's structure. These days, some are organized as grantor trusts or limited partnerships.

ETFs won't put open-end mutual funds out of business. But traditional funds will be mostly active; ETFs will be mostly passive.

Fixed-income EFTs are the fastest- growing segment of the ETF market, and there's even one of laddered bonds — and these ETFs mature when their bonds do.

Because of the flash-crash (May 6), when the stock market went nuts and lost 998.5 points during the one day, be wary of market orders — especially placing them at night. When the market opens the next morning, all hell may have broken loose.

As for stop-loss orders (sell my stock if it falls to, say, $20), they should have limits, or "collars" — something that will protect you if (say) you have a stop-loss at $20 and the market zips past $20 and plunges down to $6, at which point poor you are sold out.

Take advantage of commission-free ETFs — which probably will continue to be offered.

Actively managed ETFs are here — typically in areas that are hard to index, like alternative investments.

Many people who buy ETFs are traders, going in and out; many others are buy-and-holders. Both help the ETF market be liquid, thus making trades easier.

Typical investors in ETFs are wealthy and sophisticated — and likely to be retired.

The moderator at the conference was F. Scott Burns, director of ETF analysis at Morningstar, not to be confused with the Scott Burns who's a columnist for the Dallas Morning News.

Panelists: Peter Crawford (pictured), senior vice president, IMS Client Solutions, at Schwab; Benjamin Fulton, managing director of Invesco Powershares; Michael Iachini, CFA, CFP, director, investment management research, Charles Schwab Investment Advisory; Tom Lydon, editor, ETF Trends and president, Global Trends Investments; James E. Ross, senior managing director of State Street Global Advisors; and Sue Thompson, managing director, iShares RIA Sales.

A question I didn't get around to asking: Is the growing popularity of ETFs and indexing in general a symptom of a widespread disillusionment among investors about their lack of success in buying and selling individual stocks? After all, over the past 10 years, the average actively managed mutual stock fund, according to Morningstar, was only slightly above water; bond funds did far better.

By the way, here are five ETFs that Morningstar ETFInvestor (July 2010) favors:

Vanguard Total Stock Market (VTI), iShares S&P500 Index (IVV), Vanguard Dividend Appreciation (VIG), Vanguard Value (VTV), and Vanguard Growth (VUG).

Warren Boroson's financial column appears on Mondays.