Tim Middleton's ETF Insider

ETF Investors lose $94.14 billion in October's tempest

2008-10-31T21:23:58Z

Investors lost $94.14 billion in exchange-traded funds in October, the worst returns in the industry's short history. Broad diversification actually hampered returns, as ETFs representing foreign bourses and commodities brought the total average decline to 17.4%, worse than the 16.5% decline of SPDR S&P 500 Trust, the investable form of the S&P 500 Index, which is the largest ETF.

Forget about hiding from this bear market—it's taking down everything from Grandmother's gold to Brazil nuts. If you weren't short, you lost your shorts.

The 17.4% decline of the ETF 50 Index™, the industry's leading measure of ETF performance, brought its losses this year to 35.0%. From its peak one year ago, the ETF 50 has plunged 39.1%, compared with a 38.0% drop in the S&P 500.

ProShares UltraShort Financials (SKF), which only recently climbed into the top 50 ETFs by assets, soared 124.4% in October. The inverse two-times leveraged ETF skirts federal rules intended to limit shorting of financial stocks.

Four other ETFs that have also enjoyed substantial inflows, as investors have sought safe havens couldn't escape the month's carnage. iShares Lehman 7-10 Year Treasury (IEF) slipped 1.2%. Health Care Select SPDR (XLV) was off 11.5%. PowerShares Water Resources (PHO) slumped 25.3%, and Vanguard REIT Index ETF (VNQ) tumbled 31.7%.

Among the biggest losers were iShares MSCI Emerging Markets Index (EEM), the third-largest ETF, down 25.6%; SPDR Gold Shares (GLD), behind 16.1%; iShares MSCI Brazil Index (EWZ), off 33.1%; and Oil Services HOLDRS (OIH), down 32.8%.

The only ETF among the 50 largest to remain positive in October was iShares Lehman 1-3 Year Treasury (SHY), which eked out a 0.8% advance.

All but four of the other 49 suffered double-digit declines.

The ETF 50 Index™ represents the price-only asset-weighted performance of the 50 largest exchange-traded funds. The index consists of a broadly diversified universe of funds representing domestic and foreign stocks, bonds and commodities, and is a better indicator of actual investor returns than indices tied to particular markets.

Dollar Rally Boosts Small Caps, Routs Gold, Foreign Stocks

2008-08-29T20:47:28Z

The ETF 50 Index™, the industry's leading measure of ETF performance, slipped 1.4% in August, dragged down by foreign equities and a rout in gold as the U.S. dollar rallied sharply.

SPDR S&P 500 Trust (SPY), the largest exchange-traded fund with assets of $80.20 billion, eked out a gain of 1.5% in the month. It was only the fourth time in the last 12 months the benchmark of large-capitalization U.S. stocks outperformed the ETF 50 Index™, but it was also the second in a row.

The emerging story this summer is the relative strength of the domestic economy versus the rest of the world, which has sent the U.S. dollar sharply higher. That's bad for foreign stocks and gold bugs, and very, very good for the most economically sensitive domestic stocks, the small-cap value group.

Domestic small caps asserted strong leadership in the month, with iShares Russell 2000 Index (IWM) spurting 3.6%. iShares Russell 2000 Value Index (IWN) surged 5.2%, substantially more than iShares Russell 2000 Growth Index (IWO), which gained 3.2%.

Small companies get a greater percentage of revenue and earnings from domestic operations than multinationals. Beaten-down value stocks are most sensitive to the business cycle.

Meanwhile the second- and third-largest ETFs, iShares MSCI EAFE Index (EFA) and iShares MSCI Emerging Markets Index (EEM), sank 4.2% and 6.3%, respectively, in August.

SPDR Gold Shares (GLD), a traditional dollar hedge, tumbled 9.3%. iShares Silver Trust (SLV) collapsed 23.7%.

PowerShares DB US Dollar Bullish (UUP), which with assets of $500 million is not among the 50 largest ETFs, spurted 5.3% in August.

The ETF 50 Index™ has crumbled 10.6% in the last three months, 11.0% so far in 2008 and 12.6% in the last 12 months.

ETF 50 Index™—July 2008

2008-07-31T13:03:00Z

July Skims Another 2.0% from Investors

The ETF 50 Index™, the industry's leading measure of ETF performance, fell 2.0% in July, dragged down by a sharp fall in energy and foreign funds, notably emerging markets.

Markets are chaotic; investors are panicked by inflation, which shot up to 5.0% in the latest government report. With all this uncertainty about domestic politics and global economic conditions, money can't find anyplace to hide.

The largest ETF, SPDR S&P 500 Trust (SPY), slipped only 0.9% in July. But Nos. 2 and 3, iShares MSCI EAFE Index (EFA) and iShares MSCI Emerging Markets Index (EEM), skidded 3.3% and 5.5%, respectively. No. 4 PowerShares QQQ (QQQQ), representing the tech-heavy Nasdaq 100 Index, actually eked out a 0.6% gain. No. 5 SPDR Gold Shares (GLD) declined 1.4%.

SPDR S&P Energy (XLE) tumbled 15.7% as oil prices retreated from their historic highs. Other commodities also sank, with PowerShares Commodity Tracking Index (DBC) off 10.8% and PowerShares DB Agriculture down 9.9%.

Domestic small-cap stocks proved surprisingly resilient, with iShares Russell 2000 Index (IWM) ahead 3.3%. iShares Russell 2000 Value (IWN) spurted 4.0%. iShares Lehman Aggregate Bond (AGG) was unchanged.

Beleaguered financial stocks rallied, with SPDR S&P Financial Sector (XLF) ahead 6.9%

The ETF 50 Index™ represents the price-only asset-weighted price performance of the 50 largest exchange-traded funds. The index consists of a broadly diversified universe of funds representing domestic and foreign stocks, bonds, commodities and real estate, and is a better indicator of actual investor returns than indices tied to particular markets.

ETF 50 Index™—June 2008

2008-06-30T21:33:39Z

Stocks Melt in Oil's Heat

The ETF 50 Index™, the industry's leading measure of ETF performance, tumbled 7.5% in June, its steepest decline since the benchmark was introduced in January, 2007. It brought returns for the average ETF investor down 9.5% in the first half of 2008.

With traders throwing oil on the inflation fire, financial assets are going up in flames. Wouldn't you know Congress is trying to crack down on commodities. They're the only thing making money.

The most widely owned ETF, SPDR S&P 500 (SPY), skidded 8.8% in June. It's two-times inverse leveraged twin, ProShares UltraShort S&P 500 (SDS), leaped 17.8%.

Domestic markets were dragged down by the financial sector, with SPDR S&P Financial Sector Index (XLF) down 18.7%. Commercial real estate stocks fell to their lowest level since April 2004, with iShares Cohen & Steers Realty Majors (ICF) off 11.8%.

Bonds as well as stocks declined, with iShares Lehman Aggregate Bond Index (AGG) down 0.5%. Treasury Inflation-Protected Securites, however, performed their role with iShares Lehman TIPS Bond (TIP) ahead 1.0%.

Foreign bourses fared even worse, with iShares MSCI EAFE Index (EFA) down 10.5% and iShares MSCI Emerging Markets Index (EEM) off 10.3%. The epicenter of the overseas damage was Europe , with iShares EMU (EZU), which tracks the euro region, tumbling 14.4%.

But China and its economic satellites fared little better. iShares FTSE/Xinhua China 25 Index (FXI) was down 14.0% and iShares Brazil off 10.0%.

Commodities, a traditional inflation haven, surged higher. PowerShares Commodity Index Tracking ETF (DBC) spurted 10.5%, and PowerShares DB Agriculture (DBA) shot up 15.2%.

The ETF 50 Index™ represents the price-only asset-weighted price performance of the 50 largest exchange-traded funds. The index consists of a broadly diversified universe of funds representing domestic and foreign stocks, bonds, commodities and real estate, and is a better indicator of actual investor returns than indices tied to particular markets.

How ETF Share Splits Work

2008-06-24T19:03:09Z

Earlier this month, Vanguard Group declared a 2-for-1 split of Vanguard Emerging Markets (VWO), Vanguard Total Stock Market ETF (VTI) and Vanguard Extended Market ETF (VXF) to bring down their prices. (The record date was June 13, and the shares began trading at their split-adjusted price June 18.) Because splits can cause confusion for some investors, I'd like to explain how they work and how your holdings will be affected when a split occurs.

Most ETFs, like most stocks, trade for prices below $100 to attract individual investors. When they breach that barrier, they usually split. Before the recent Vanguard split, for instance, VWO traded above that price.

Among stock investors, a split is applauded as a sign of success, and novice investors are routinely suckered into buying ahead of splits because they think something magic is about to happen. In fact, it's simply an accounting mechanism. If a $100 stock splits 2-for-1, investors are left with twice as many shares, each worth half as much.

Warren Buffett has never split the shares of Berkshire Hathaway, and the A shares (BRK.A) have traded recently around $130,000. But under shareholder pressure, he did allow the creation of Class B shares (BRK.B), worth 1/30th of a Class A share. Even so, their recent price of more than $4,000 limits their popularity.

Some 58 ETFs, or 7.9% of the total outstanding, trade for more than $100. Except for bookkeeping purposes, however, the share price of an exchange-traded fund, as for a mutual fund, is immaterial. It's simply the value of its holdings divided by the number of shares outstanding.

But even mutual funds strive to keep their net asset value per share below $100. Only 0.3% of mutual funds have higher per-share prices, according to Morningstar.

Just remember to record the change in your files for any ETFs you own that split their shares, or you'll suffer a phantom loss that's bound to be upsetting.

ETF 50 Index™—May 2008

2008-05-30T21:21:46Z

A diversified portfolio of exchange-traded funds continued to outrace the beleaguered market in May, with the ETF 50 Index™, the industry's leading measure of ETF performance, rising 1.8%.

The investable form of the S&P 500 Index, SPDR S&P 500 Trust (SPY), managed a 1.5% gain in the month, topping foreign developed markets as the U.S. dollar staged a small rally. iShares MSCI EAFE Index ETF (EFA) eked out a 1.2% advance.

The United States is where the money is now, and that's where ETF investors are reaping the biggest rewards. Oil and U.S. stocks have been in a tug of war for months, and U.S. stocks are starting to win.

Domestic markets showed their greatest strength at the most economically sensitive end of the spectrum, with PowerShares QQQQ (QQQ), representing the Nasdaq 100, surging 5.9%, and iShares Russell 2000 Index (IWM), representing small-capitalization stocks, ahead 4.6%.

By contrast, iShares MSCI Emerging Markets Index (EEM) gained only 3.2% in the month.

But the domestic rally is riddled with troublesome holes. The group that led stocks into a bear market, represented by Financial Select Sector SPDR (XLF), tumbled 6.6% in May as losses in that sector continued to spread.

The month's biggest gainer was iShares MSCI Brazil Index (EWX), which roared ahead 9.9%, buoyed by reports of the largest oil find in at least a decade off its shores.

Energy Select Sector SPDR (XLE) spurted 5.2%.

The ETF 50 Index™ has advanced 5.2% in the last three months but remains down 2.2% since May 2007. The 500 Spider is up 4.9% in three months and down 8.5% in the last 12.

The ETF 50 Index™ represents the price-only asset-weighted price performance of the 50 largest exchange-traded funds, which account for nearly 75% of the industry's total assets. The index consists of a broadly diversified universe of funds representing domestic and foreign stocks, bonds and commodities, and is a better indicator of actual investor returns than indices tied to particular markets.

ETF 50 Index™—April 2008

2008-04-30T21:12:57Z

The ETF 50 Index™, the industry's leading measure of ETF performance, spurted 4.8% in April, its biggest gain in the last year.

The swagger is back on Wall Street. Risk has become yesterday's problem. Investors are convinced the bear market is over, and the recession will be, soon.

Markets rallied broadly, in terms of regions as well as sectors. SPDR S&P 500 Trust (SPY) gained 4.8%, PowerShares QQQ (QQQQ) 8.0%, iShares MSCI Emerging Markets Index (EEM) 9.3% and Financial Sector SPDR (XLF) 7.1%.

Bonds were lower as investors reacted to a shift in interest-rate policy from lavish cuts to looming hikes. iShares Lehman Aggregate Bond Index (AGG) slipped 0.1%, and iShares Lehman 7-10 Year Treasury (IEF) ebbed 1.1%.

Precious metals continued the retreat they began in March. StreetTracks Gold Trust (GLD) declined 4.1%, and iShares Silver Trust (SLV) was off 1.9%.

Two bear-market ETFs that had bulked up on assets in the first quarter to join the 50 largest got creamed, both because they represent the inverse of winning indices and because they are leveraged to twice the scale. UltraShort S&P 500 ProShares (SDS) sank 10.0%, and UltraShort Financials ProShares (SKF) tumbled 14.1%.

The ETF 50 Index™ is ahead 2.1% in the last three months, down 3.9% year to date, and behind 0.9% over the last 12 months.

The ETF 50 Index™ represents the price-only asset-weighted price performance of the 50 largest exchange-traded funds. The index consists of a broadly diversified universe of funds representing domestic and foreign stocks, bonds and commodities, and is a better indicator of actual investor returns than indices tied to particular markets.

ETF 50 Index™—March 2008

2008-03-31T21:11:29Z

The ETF 50 Index™, the industry's leading measure of ETF performance, slipped 1.4% in March, its fifth loss in as many months. But in a re-evaluation of global risk, foreign markets—which had been marching in lockstep with the Standard & Poor's 500 Index—diverged, with Europe turning up and everything else, notably emerging nations, running down.

Commodities also faltered in the month, with StreetTracks Gold Shares (GLD) sinking 6.0%.

The marionette markets are taking a hold of their own strings. Decoupling turns out to be working.

The ETF 50 Index™ had been outperforming SPDR S&P 500 Index (SPY) for most of the last year, but in March achieved parity. That means there was no refuge in March. And when there is no refuge, U.S. stocks are themselves the refuge, because over time they beat everything else.

Domestic technology issues were among the month's few winners, with the tech-heavy Nasdaq, represented by PowerShares QQQ (QQQQ), advancing 1.8%. European markets resisted the downturn, with iShares MSCI EMU Index (EZU), which tracks the euro zone, up 2.6%.

Also in March, domestic small-capitalization stocks outperformed their larger brethren, after lagging them for more than a year. iShares Russell 2000 Index (IWM) declined only 0.8% during the month, roughly 40% less than the Spider's 1.4% fall. Small caps are more economically sensitive, so this outperformance is bullish for the market and the economy.

In general, foreign markets were weak, with iShares MSCI Japan Index (EWJ) down 1.3%, while iShares MSCI Brazil Index (EWZ) tumbled 8.1%. iShares MSCI Emerging Markets Index (EEM) was down 3.9%.

The ETF 50 Index™ was off 8.3% in the first quarter, while the Spider tumbled 9.3%. Over the last 12 months, the ETF 50 Index™ has declined 2.2%, compared with the 7.4% loss of the Spider.

The ETF 50 Index™ has declined 16.3%% in the last five months, as the global bull market that began five years ago corrects. But February (minus 1.2%) and March experienced much smaller declines than November (minus 4.5%) and January (minus 5.9%).

The ETF 50 Index™ represents the price-only asset-weighted price performance of the 50 largest exchange-traded funds. The index consists of a broadly diversified universe of funds representing domestic and foreign stocks, bonds and commodities, and is a better indicator of actual investor returns than indices tied to particular markets.

ETF 50 Index™—February 2008

2008-02-29T22:51:53Z

The ETF 50 Index™, the industry's leading measure of the performance of the exchange-traded fund marketplace, declined 1.2% in February. That was the benchmark's best return since October 2007, as weakness in foreign and domestic developed markets was partially offset by the strength of commodity and emerging markets ETFs.

The developing world is not giving in to slowing economic growth, but the developed world is, U.S. stocks look like they're sick of tryin'.

The ETF 50 Index™ fell 7.6% in the first two months of 2008. It was down 8.8% in the last three months, and ahead 0.4% in the last 12. The index has been down in six of the last 12 months.

The two most widely held ETFs, SPDR S&P 500 Trust (SPY) and iShares MSCI EAFE Index (EFA), declined 2.6% and 1.0%, respectively. PowerShares QQQ (QQQQ), representing the volatile Nasdaq 100, sank 4.8%.

The big winners were iShares MSCI Taiwan Index (EWT), up 12.7% in February, iShares MSCI Brazil Index (EWZ), up 10.2%, and Select Sector Energy SPDR (XLE), ahead 8.5%. StreetTracks Gold Shares (GLD) gained 5.2%. iShares MSCI Emerging Markets Index (EEM), the third-largest ETF, advanced 2.1%.

The ETF 50 Index™ represents the price-only asset-weighted price performance of the 50 largest exchange-traded funds. The index consists of a broadly diversified universe of funds representing domestic and foreign stocks, bonds and commodities, and is a better indicator of actual investor returns than indices tied to particular markets.

ETF 50 Index™—December 2007

2008-01-02T20:56:59Z

The ETF 50 Index™, the industry's leading measure of ETF performance, sank 1.9% in December to finish the year ahead 8.5%.

Only five of the 50 largest exchange-traded funds finished the month in the black, paced by the 8.0% advance of the Energy SPDR (XLE) and a gain of 6.7% for StreetTracks Gold (GLD).

The biggest losers were foreign-stock funds, including iShares MSCI EAFE Index (EFA), down 5.4%, and iShares FTSE/Xinhua China 25 (FXI), off 9.1%. iShares MSCI Emerging Markets Index (EEM) declined 2.7%.

SPDR S&P 500 Index (SPY) slipped 1.7% in the month. Most domestic equity ETFs were little changed in December, except for the Financial SPDR (XLF) and iShares Cohen & Steers Realty Majors (ICF), each down 6.7%.

The final four months of 2007 were the most volatile of the year, up sharply in September and October and down steeply in November.

ETF 50 Index™—November 2007

2007-11-30T20:54:01Z

The ETF 50 Index™ sank 4.5% in November, its largest monthly decline of the year, dragged down by double-digit losses in Asian exchange-traded funds, notably iShares FTSE/Xinhau China 25 ETF (FXI), which tumbled 14.2%.

The two largest ETFs, SPDR S&P 500 Trust (SPY) and iShares MSCI EAFE Index (EFA), declined 3.9% and 3.6%, respectively. They account for 30.5% of the index, which in turn represents 76.8% of all ETF assets.

But the next two-largest, iShares MSCI Emerging Markets Index (EMM) and the technology-heavy PowerShares QQQ (QQQQ), did much worse, shedding 7.6% and 6.8%, respectively, of their value. They account for 10.1% of the index.

iShares MSCI Korea (EWY) dropped 11.3%, and iShares Taiwan (EWT) was off 12.3%.

Small-cap domestic stocks continued to weaken, with iShares Russell 2000 Index (IWM) sliding 6.9%.

Only six of the 50 largest ETFs delivered positive results in the month: five bond funds and Select Sector SPDR Utilities (XLU), which was ahead 0.7%. The biggest gainers were iShares Lehman 7-10 Year Treasury Bond (IEF), up 3.7%, and iShares Lehman TIPS Bond (TIP), up 3.8%.

Over the last 11 months the ETF 50 Index™ has advanced 10.6%, more than twice the gain of SPDR S&P 500 Trust .

ETF 50 Index™—October 2007

2007-10-31T19:48:33Z

ETF investors racked up average gains of 3.8% in October, greatly outperforming the broad domestic stock market. But U.S. technology stocks did make a statement, with PowerShares QQQ (QQQQ) shooting up 7.0% in what is usually a strong season for that sector.

SPDR S&P 500 Trust (SPY) advanced only 1.4% in the month, greatly eclipsed by the 4.3% return of iShares MSCI EAFE Index (EFA), the corresponding benchmark for foreign equities. Vanguard Emerging Markets ETF (VWO) shot up 13.0%, propelled upwards in particular by soaring markets in China and Brazil.

Foreign bourses continue to greatly outperform the domestic market, owing both to their own strength and to the continuing weakness of the U.S. dollar. The only significant loser in October was the financial SPDR, which shed 2.0% of its value as the credit crisis continues to search for a bottom.

iShares Brazil Index (EWZ) spurted 16.4% in October, and iShares FTSE/Xinhua China 50 Index (FXI) ballooned 21.4%.

The weaker dollar, and inflation fears, found expression in the 7.0% boost in the price of StreetTracks Gold Shares (GLD), which tracks the metal's spot price.

The ETF 50 Index advanced 9.5% in the last three months and is ahead 15.8% so far this year. SPDR S&P 500 is up 6.1% in the three months and 9.2% year-to-date.

October's performance was second this year only to September's 4.7% gain.

The ETF 50 Index™ represents the asset-weighted price-only performance of the 50 largest exchange-traded funds, which account for 76.8% of total ETF assets. The index consists of a broadly diversified universe of funds representing domestic and foreign stocks, bonds, commodities and real estate, and is a better indicator of actual investor returns than indices tied to particular markets.

How to Take Income From an ETF Portfolio

2007-10-18T20:52:12Z

Recently I got this email from one of our subscribers:

Tim, what's the easiest way to withdraw funds from income that ETFs produce?--T.W.

I recommend these three rules to income investors of all stripes, whether they use stocks, mutual funds or ETFs:

Collect dividends as cash -- Never automatically reinvest dividends. (With ETFs, this is easy.)
Focus on total return, not yield -- Plan to draw half your income from distributions and the other half from the sale of ETF shares.
Sell shares on a schedule -- Time the sales to the middle of the month, the middle of the quarter, and not December.

Those are the guidelines; now let's talk about what each means for ETF investors.

Collecting dividends as cash

ETFs are very well suited to income investors. Unlike mutual funds, distributions cannot be automatically reinvested, so they go directly into your cash account. (Some brokerages offer a dividend reinvestment plan that can then automatically reinvest them for you.) And whereas mutual funds are required to distribute taxable capital gains to their shareholders, ETFs can be managed so such gains are avoided. PowerShares, for example, has never made a cap-gains distribution on any of its funds.

This tax-friendly characteristic minimizes the possibility you'll buy a fund immediately ahead of a big distribution, which would cause you to owe taxes on what amounts to a return of your capital. That is, even though the value of your investment hasn't changed from just before the distribution to just after it, you still owe taxes on the gains the fund made during the year before you bought the shares.

So the nature of ETFs means that income distributions, from interest and dividends, arrive as often as monthly. Let's use Vanguard Total Bond Market ETF (BND) as an example. Somewhere between the fifth and the 10th of each month, this fund has paid distributions around 25 cents to 30 cents a share, which works out to an annual yield of 5.12%. iShares iBoxx $ Investment Grade Corporate Bond Fund (LQD) is yielding 5.63%, paying out monthly dividends recently of between 45 cents and 50 cents a share on a schedule similar to that of the Vanguard fund.

Even many equity ETFs have significant yields. iShares MSCI EAFE Index Fund (EFA) distributes dividend income annually in December; last year the distribution was $1.53346. (ETFs typically pay distributions in fractions of pennies. Most stocks and mutual funds do not.) That's equal to a yield of 1.84%, based on its recent share price. Vanguard Large Cap ETF (VV) yields 1.73% and pays quarterly.

Generally speaking, the record, ex-dividend and pay dates of income ETFs fall within a total period of five to seven days. For example, Vanguard Total Bond began trading ex-dividend on Oct. 1 to shareholders of record Oct. 3, and paid the distribution on Oct. 5.

There is one big exception to this rule: SPRD S&P 500 Trust (SPY), the most widely held ETF of all. It yields 1.77% and also pays quarterly. The next distribution will be $0.7187, paid on Oct. 31. But the ex-dividend date on those shares was Sept. 21. So planning an income stream from this fund is a bit of a headache. Fortunately, it's not one of our Model Portfolio holdings.

Focus on total return, not yield

My ETF Insider Model Income Portfolio is designed for an investor who takes the first 5% of its total return each year as income and leaves the balance of at least several percentage points to continue growing. Of this 5% return, about half comes from distributions. The other half comes from regular sales of ETF shares to make up the difference. On a $100,000 portfolio, that means distributions in the course of a year of $2,500 and the sale of $2,500 worth of ETF shares--perhaps 50 shares of ETFs with average prices of $50.

To return to our example of iShares MSCI EAFE Index Fund, it generated average total returns of 23.3% in each of the five years ended Sept. 30, 2007. That makes it a likely candidate to be trimmed from time to time to keep it in line with an asset-allocation target of 15%.

When to sell shares

I recommend timing sales of fund shares so they don't fall close to ex-dividend dates, which means the middle of the month for ETFs that make monthly distributions, the middle of the quarter for most equity ETFs, and November or January for funds that make one distribution in December.

Alternative approaches: fixed income vs. inflation

The alternative to my approach to income investing is to seek higher yields, and many retirees have substantially all of their investments in bonds for this reason. That creates, however, the dreaded fixed income. Expenses are not fixed; from property taxes to gas for the car, they go up and up.

My approach has inflation protection built in, because total returns are greater than income requirements, and your kitty--and your income stream--is constantly growing. Twenty years into retirement this approach provides twice the cash it did at the start, and at least the same amount of purchasing power. By contrast, a bond portfolio will be providing a steady stream of cash that's worth half as much then as it is now.

Income investing is really risky when you don't take any investment risk. The risk of inflation can't be avoided.

Transitioning a Portfolio to ETFs

2007-10-12T20:10:35Z

Whether or not you're a new investor, ETFs are probably new to you. Nearly half of all of these streamlined, low-cost portfolios have been introduced this year. When the bear market started seven years ago there were 30 of them; since the bulls began running in 2003, their numbers have exploded to more than 550.

Many of us, therefore, are in the process of transitioning our portfolios to incorporate more ETFs in place of traditional mutual funds, or adding ETFs to our other holdings. Our reasons are many: to trim expenses; to consolidate in a single account investments that might be spread among numerous mutual fund families; to avoid the risk that our managers will change or falter. One ETF Insider subscriber dropped me a note recently as she addressed this issue:

Tim, I'm totally in a Vanguard IRA. I've been following Dan Wiener's conservative growth portfolio model, somewhat modified. (Doing good!) How do I go about switching some money to ETFs? B.G.

Dan, the editor of The Independent Adviser for Vanguard Investors (and a friend of mine), focuses primarily on actively managed mutual funds in his model portfolios because he knows that some of Vanguard's top managers are index-beaters. But he's a believer in ETFs, and I think he would agree with this advice--in fact, I've asked him, and incorporated his ideas here:

If you're a Vanguard investor, as B.G. is, then the first step is to exploit Vanguard's own family of ETFs, most of which are clones of their existing index mutual funds with the added benefit of exceptionally low expenses. For example, the short-term investment-grade bond mutual fund he recommends in his conservative growth portfolio has an ETF analog, Vanguard Short-Term Bond ETF (BSV). It isn't exactly the same, but it's a close match. Vanguard Emerging Markets mutual fund is available as Vanguard Emerging Markets ETF (VWO). Dan himself recommends the emerging markets ETF over the open-end fund because of the fund's 0.5% front-end and back-end loads. Those loads can cost you a lot more than most brokerage fees for buying the ETF will.

Anytime you're examining this kind of transition, first determine what benchmark the mutual fund you own compares itself with. You can find that out in fund literature, e.g., the fund's prospectus, or from an analysis service like Morningstar. Virtually without exception, those benchmarks are available as purebred ETFs. For example, if the actively managed fund's benchmark is the Russell 2000, a popular small-cap index, the corresponding ETF is iShares Russell 2000 Index (IWM). You may decide that the index route, using ETFs, is your preferred strategy.

Of course, when you make this kind of transition, you make a trade-off. ETFs are index funds, and some active mutual fund managers consistently beat their indexes. But mutual funds have overhead that ETFs don't, including the cash they have to hold in reserve, whether to meet redemptions or because they haven't put it to work yet. The typical mutual fund sets aside 5% of assets in this manner; with ETFs, 100 cents of every dollar are put to work. In a bull market, having all your dollars invested is an advantage. When the markets turn down, of course, that cash holding may help preserve capital a bit.

I own every ETF in the ETF Insider Model Portfolios , but I also own a number of mutual funds that I've had for years. (My personal retirement portfolio is so similar to the ETF Insider Growth Model Portfolio that the performance of the two has been identical in recent months.) Like our subscribers, I'm always on the lookout for ways to exploit ETFs to make my portfolio more fully diversified, efficient and economical to own. Techniques like these are part of the research I do to identify ETFs that contribute the most to my, and your, total portfolio satisfaction.

ETF 50 Index™—September 2007

2007-10-02T19:38:30Z

The ETF 50 Index™ finished September ahead 4.7%, its largest monthly gain this year. The benchmark of the most widely held exchange-traded funds advanced 3.5% in the third quarter to finish the first nine months of the year ahead 11.5%.

Despite the spreading credit mess and the continuing weakness of small-cap stocks, investors are racking up solid and accelerating advances. ETF investors racked up gains of $17.20 billion in September, bringing their year-to-date profits (exclusive of new flows) to $48.54 billion.

And despite a flight from risk that began in August, September's biggest gainers included iShares Brazil Index (EWZ), up 19.5%, iShares FTSE/Xinhua China 50 Index (FXI), up 19.8%, and iShares Latin America 40 (ILF), ahead 13.8%. The more-diversified iShares Emerging Markets Index (EEM) advanced 11.6%.

SPDR S&P 500 (SPY) was ahead 3.4% in the month.

Reflecting inflation fears stoked by the Federal Reserve's half-point cut in interest rates during the month, StreetTracks Gold Shares (GLD) spurted 10.5% in September.

Among domestic stocks, the weakest groups were small caps, finance and value securities. iShares Russell 2000 Index (IWM) crawled ahead 1.5%, the Financial SPDR (XLF) 1.7% and iShares S&P Mid Cap 400 Barra Value (IJJ) 1.4%.

The ETF 50 Index™ posted its second-best 2007 performance in April with a gain of 3.4%. The biggest monthly decline was July's 1.8% slide.

The ETF 50 Index™ represents the asset-weighted price performance of the 50 largest exchange-traded funds. It consists of a broadly diversified universe of funds representing domestic and foreign stocks, bonds, commodities and real estate, and is a better indicator of actual investor returns than indices tied to particular markets.