I've researched ad naseum this topic and the only thing I concluded was that MFs charge fees, require minimum investments, and can automatically reinvest dividends, ETFs have none of these. As far as my Roth investments go, I am looking to invest for the long term, obviously (I am 25 now). My plan is to invest my annual contribution 50% in the broad market and 50% in an "investment of the year". Regardless, what is the big difference, with respect to my age and the overall rate of return between, say, the Vanguard 500 fund and the SPDR?

This is my first post in here....feel free to ream me for my ignorance or misspellings

 

Which SPDR? There are many.

 

SPY

 

Over the last five years VFINX and SPY look like this:

Annual compounded return

VFINX: 6.78%
SPY: 6.76%

Annual risk (standard deviation of monthly returns)

VFINX: 13.10%
SPY: 12.98%

Correlation of monthly returns

+99.71%

Over the last ten years they look like this:

Annual compounded return

VFINX: 8.46%
SPY: 8.36%

Annual risk

VFINX: 16.47%
SPY: 16.29%

Correlation of monthly returns

+99.65%

In short, they're virtually identical.

 

Bear in mind that ETFs have per transaction fees (buy/sell) so it would not be a good product if you were planning to contribute small amounts monthly toward your retirement accounts. This product is beneficial for investors who have high dollar transactions to leverage the fees or if one plans on holding onto funds with a minimal frequency of contributions.

 

The real difference between EFTs and Mutual Funds is that ETFs are index funds with no management. They contain a static basket of stocks which change only based on specific criteria automatically. Because they have no manager they also have no fees. You buy them just like stocks with the normal equity trade commission from your broker.

ETFs provide a way to buy a specific basket of stocks, like a sector, an industry, a country and region, etc. which trade domestically and all at one time rather than buying and building your own basket with individual equities.

They require some management on your part, more than a Mutual Fund but less than building your own. For example, if you want to invest in oil services as an industry you can buy the OIH ETF rather than buying 2 or 3 individual oil services stocks.

 

The reason they attracted me is that with them, I could dial in my level of diversity better than with MFs with loads of holdings.

So, as far as an IRA investment. It doesn't really matter?

 

They follow whatever market they index. It doesn't matter IMO so long as you diversify and be smart and manage your risk tolerance. Any market correction will hit you just as it would a MF.

 

cthree,

Similar to the OP's question, I'm 26 and have Edward Jones draft a set amount monthly into my Roth IRA. I have a huge tolerance for risk (I don't even look at it most of the time.) Wouldn't the most volatile portfolio take the most advantage of dollar cost averaging at this point in my life? I'm concerned my rep is too conservative. I don't really care if it looks like I'm losing on paper, even for 3 years. As long as I'm collecting shares, I look at it like everthing's on sale!

Thx for the help,
Tom

 

Yes: you'll get lots of opportunities to buy when the portfolio is down. Good for dollar cost averaging, bad for growing a retirement fund. Personally, I'd rather have an portfolio that's never down.

In short, looking at volatility alone is silly. Ask yourself this: would you rather have an investment with an expected return of 10% and volatility of 15%, or an expected return of 15% and volatility of 10%? The former has higher volatility; the latter is a (much) better investment.

The general rule is this: more risk (volatility), more return. The problem with the general rule is that it is just that: a general rule. You're not investing in general; you're investing in the specific portfolio you've chosen. Specific portfolios don't follow general rules, they follow specific rules: their risk is their risk and their return is their return.

All of this means what? If you have high risk tolerance, look for investments with high expected returns, choose the least risky for an acceptable level of return, and be prepared for a roller coaster ride. If you have low risk tolerance, look for investments with low expected returns, choose the least risky for an acceptable level of return, and be prepared for a pram ride. Note the common step: when choosing amongst investments having an acceptable level of return (whether high or low), choose the lowest-risk investment. (Another way of looking at it is this: from among the investments that have a level of risk you can tolerate, choose the one that has the highest expected return. It's tantamount to the same thing.)