Index Funds vs ETFs

[Bylo Selhi]

Practical ETF Investing: The Online Calculator

Does it make sense to become an ETF (exchange-traded-fund) investor? I think so. The smaller the commission cost of buying and selling— measured as a percent of assets invested— the more attractive ETF investing is. The surprise is that it makes sense for relatively small portfolios...

The ETF Portfolio Cost Calculator has its flaws, e.g. if you want to make monthly purchases you have to specify that you rebalance 12 times per year, but it's a good starting point for comparing the costs of investing in ETFs vs. open-end index funds.

[Note to geeks: Burns' web page was created using SpreadsheetConverter. It's a cool tool although a bit pricey for individuals.]

[WishingWealth]

Since this is a new thread on subject, I'll just link If You’re Playing ‘Beat the Benchmark,’ Don’t Expect to Win here.

GOOD old-fashioned indexing — the plain-vanilla strategy of buying and holding all the stocks in a broad market benchmark like the Standard & Poor’s 500 — became popular in the late 1990s, when the major stock indexes were returning more than 20 percent a year.

But investors who’ve recently turned their back on this strategy are probably regretting their decisions.

This year through September, only 28.5 percent of actively managed large-capitalization funds — which try to beat the market through stock selection — were able to outpace the S.& P. 500 index of large-cap stocks, according to a new study by S.& P. In the third quarter alone, it was even worse, with only one in five actively managed large-capitalization funds beating the index.

That isn’t terribly surprising, said Rosanne Pane, mutual fund strategist at S.& P., because active managers tend to have difficulty beating indexes when market leadership changes. And in the third quarter, many stocks that had paced the market for much of this decade began to fall behind. Small-company stocks were finally beaten by shares of big, blue-chip companies; sectors like energy also started to lose ground.

Still, such transitional periods aren’t the only good times for indexing. S.& P. research shows that while active management fared poorly in the third quarter, it has actually been lagging behind the indexes for a considerable period.

....

In the NY Times.

WW

Added:
Same article with the graph; the other was 'the 'printer friendly' version

[oldguy]

Since this is a new thread on subject, I'll just link If You’re Playing ‘Beat the Benchmark,’ Don’t Expect to Win here.

ETF against Managed Funds .... again ...... HUM

I'm probably the last person on earth that prefers managed funds over ETF and I know that I'll get blasted once again , but......

Now that GlobeFund includes XIC and XIU in the Canadian Dividend and Equity Income list we are able to compare apples with apples. I always saw it that way even when GlobeFund listed them in the Equity Pure list.

The great thing with ETF is low MER. But I think that there is too much focus on that. Buying a Mutual Fund is not strictry buying a low MER.

The other publicity we hear is that ETF beat most Managed Funds. This is true. There's even more truth to this in the better years. But what about the bad years . This is where good Management is important. It's in those bad years that a well Managed Fund will offer protection.

Look at the years 2001 - 2002 ( no load funds )

http://globefunddb.theglobeandmail.com/ ... fundFilter

So I don't care if an ETF beats my Managed Fund 4 years in a row. Long-Term returns and a smoother ride is more important as the end result will almost be the same.

Yes, we've already discussed in another topic the usefullness of high volatility in a well balanced portfolio , but I still prefer GOOD ( not any ) management to ETF.

[George$]

So I don't care if an ETF beats my Managed Fund 4 years in a row. Long-Term returns and a smoother ride is more important as the end result will almost be the same.

Yes, we've already discussed in another topic the usefullness of high volatility in a well balanced portfolio , but I still prefer GOOD ( not any ) management to ETF.

OK I'll bite. How do you define (and find?) GOOD management?

Allow me to play the devil's advopcate. Is 5 years of beating an index sufficient and necessary critera to define good management?
How do you distinguish between "luck" and "good"? Or how can you convince me you are not being "fooled by randomness"?

I raise these issues because for some 25 years I tried to answer them to my own satisfaction - and failed.

The smoother ride is easy I think. Just add more short term bonds into the asset allocation.

[NormR]

Practical ETF Investing: The Online Calculator

Does it make sense to become an ETF (exchange-traded-fund) investor? I think so. The smaller the commission cost of buying and selling— measured as a percent of assets invested— the more attractive ETF investing is. The surprise is that it makes sense for relatively small portfolios...

The ETF Portfolio Cost Calculator has its flaws, e.g. if you want to make monthly purchases you have to specify that you rebalance 12 times per year, but it's a good starting point for comparing the costs of investing in ETFs vs. open-end index funds.

[Note to geeks: Burns' web page was created using SpreadsheetConverter. It's a cool tool although a bit pricey for individuals.]

Perhaps a thread title change is in order to avoid the old active fund vs ETF stuff. Something like index funds vs etfs?

[oldguy]

OK I'll bite. How do you define (and find?) GOOD management?

Allow me to play the devil's advopcate. Is 5 years of beating an index sufficient and necessary critera to define good management?
How do you distinguish between "luck" and "good"? Or how can you convince me you are not being "fooled by randomness"?

I raise these issues because for some 25 years I tried to answer them to my own satisfaction - and failed.

The smoother ride is easy I think. Just add more short term bonds into the asset allocation.

First of all , may I say that I am not trying to convince anyone that managed funds are better , it's just that there is so much propaganda on the net saying that index funds are the way to go and yet my own short experience tells me the opposite.

I appreciate that you play the advocates devil. In the end I may see the light and become a defenser of index or ETF.

I agree with you that 5 years of beating the index is not a sufficient criteria to define good management , especially the last five years.

In 1963 there were 26 mutual funds available and in 2005 there were 1695 funds available. Not counting the funds that have disappeared , that makes for a lot of funds and a lot of management. However , it is possible to obtain data on funds that date back as far as 1934. Yes , World Economics and management teams have changed a lot since then.

When I search for good management I like to go back some 20 or 25 years. Within those 25 years, there have been enough cycles , recessions and crashes to see how management teams have reacted or to see how their funds have fared compared to their peers or an index when there is one. If the fund is above average or beats the index on 5-10-15-20-year long-term returns and the funds show that they were better protected in bad times , it simply means that the management team did something right. A 20-year winning streak is more than luck. Next , I look to see if it's still the same team that is managing the fund. There are usually no more than 2 or 3 funds that stand out per asset class. So far this method has served me well.

Add-in : I also look at Return vs Volatility and volatility becomes secondary if the ratio of long-term returns is higher than long-term volatility.

As for adding short-term bonds for a smoother ride , I agree . However there will be less growth in the long-term and more immediate taxes.

If my way of doing things sounds idiotic to you , please , don't blast me , just show me a better way.

[George$]

... just show me a better way.

Don't think it can be showed. One must come to one's own conclusion.

If you haven't read John Bogle's books and/or web articles, I encourage you to do so. He has a lot of experience and presents compelling data.

For what it's worth here are my views.

Firtst I go with low cost (important!!) index funds for our core investments. That provides low cost and broad diversification.

After that my second choice is individual stocks - with a buy and hold mindset. Either look for value situations (like Norm does) or large steady dividend providers or gamble for the ten bagger (I did accomplish that with Microsoft) with money you don't mind losing.

In short I want both broad diversification at low cost - as well as individual concentrated opportunity with extra money I can afford to lose.

Going after actively managed funds does not give you either - no low cost diversification - nor does it offer the opportunity of exercising concentrated judgment.

For about 25 years (from age 25 to 50) I did search for the "good" fund manager - and finally decided I had wasted the 25 years. Oh yeah at times I thought I had found one - only to eventually see them fail in one way or another. John Bogle's first book confirmed everything I had learned the slow, expensive, and hard way.

But to each his own life and money.

[oldguy]

John Bogle's first book confirmed everything I had learned the slow, expensive, and hard way.

Thanks , I too am learning the slow way and hard way. I've been fortunate enough so far not too loose money . You and other members of this forum are making me realise that I should have a serious look the construction of my portfolio.

Your explanation on index funds makes sense as to how and why they're used.

Now , I'm out to read John Bogle

[Bylo Selhi]

Now , I'm out to read John Bogle

FWIW I think his second book, Common Sense on Mutual Funds, is better than his first, Bogle on Mutual Funds. But before you spend any money on his books (or even visit a library), check out his speeches and essays at the Bogle Financial Markets Research Center. Many of his speeches from the late 1990s are classics.

[patriot1]

It's in those bad years that a well Managed Fund will offer protection.

Yeah OK.

So how does a fund manager know in advance that it's going to be a "bad year?". And what kind of "protection" can a fund offer, such as going into cash, that an individual can't perform at lower cost?

[scomac]

It's in those bad years that a well Managed Fund will offer protection.

Yeah OK.

Is this even accurate? I know that it is a widely held belief, but I believe the actual statistical performance comparison of active and passive in down markets has shown that no such protection is actually offered.

[YogiBear]

It's in those bad years that a well Managed Fund will offer protection.

Yeah OK.

Is this even accurate? I know that it is a widely held belief, but I believe the actual statistical performance comparison of active and passive in down markets has shown that no such protection is actually offered.

A number of studies of active mutual fund managers have shown that cash holdings tend to be at their maximum at market bottoms, while only minimal cash tends to held at market tops- IOW, the exact opposite of what would be required to offer any real protection.

IOW, it does no good whatsoever to increase cash allocations during and after a decline, since the loss that is supposed to be protected against has already occurred- to be effective, the cash would have to be held just before the decline (when the selling price of non-cash assets is at their maximum).

There is no surprise in this, since active fund managers are subject to the same behavioral herding impulses as the rest of us- as well as being under specific pressures of their own from unitholder and management company shareholder expectations.

[Bylo Selhi]

There is no surprise in this, since active fund managers are subject to the same behavioral herding impulses as the rest of us- as well as being under specific pressures of their own from unitholder and management company shareholder expectations.

Also indexing tends to work best in rising markets. That's because index funds hold little cash so they fully participate in the rallies. That's also why they tend to do their poorest during market declines. Of course, since in the long run markets have historically risen, this characteristic has an overall positive effect on index funds returns compared to actively-managed ones.

[YogiBear]

Also indexing tends to work best in rising markets. That's because index funds hold little cash so they fully participate in the rallies. That's also why they tend to do their poorest during market declines. Of course, since in the long run markets have historically risen, this characteristic has an overall positive effect on index funds returns compared to actively-managed ones.

Dunn's Law (Revisited)- see also here for a somewhat different (but more statistically-oriented) view, and numerous articles by the good doctor (search the site under "dunn's law").

There is also the point- which apparently can never be repeated enough - that one should not seek "protection" from individual asset classes viewed in isolation (as is the case when looking for an active manager who is "good" in bear markets). "Protection" comes from diversification across many- poorly correlated- asset classes, so that bear market blues become a profit opportunity due to rebalancing. No need to worry about "protection", no need to chase after the elusive, supposed "good" active manager ...

[Bylo Selhi]

Dunn's Law

What would Steve know about finance? After all he's just a lawyer

(Actually I've met Steve Dunn and I can tell you he's one sharp dude. Even if his day job is lawyer )

Added: An anecdote about Steve and Dr Bill. I met them both at a Vanguard Diehards "reunion" in Chicago a few years ago, first Steve and then a few hours later Bill. Bill told me that while they're good friends and have had many discussions online and over the phone, that he's never actually met Steve in person. It was my great pleasure to introduce them to each other

[oldguy]

There is no surprise in this, since active fund managers are subject to the same behavioral herding impulses as the rest of us- as well as being under specific pressures of their own from unitholder and management company shareholder expectations.

Also indexing tends to work best in rising markets. That's because index funds hold little cash so they fully participate in the rallies. That's also why they tend to do their poorest during market declines. Of course, since in the long run markets have historically risen, this characteristic has an overall positive effect on index funds returns compared to actively-managed ones.

I do not hold the following funds ( which is why I chose them ) nor is this a proposition for anyone to buy these funds but a picture is worth a thousand words.

This is a 10 year chart

http://globefunddb.theglobeandmail.com/ ... UBLIC_FUND

Also look at the 5-year chart

Unfortunately I cannot get 10-year-tax-adjusted-returns data but here are 5-years.

BMO Dividend : 13.07
RBC Dividend : 12.66
Iunits TSX 60 : 12.35

[YogiBear]

a picture is worth a thousand words.

Nortel.

If you think there will be another Nortel, go active. If not, look again at the tax adjusted returns you posted:

Unfortunately I cannot get 10-year-tax-adjusted-returns data but here are 5-years.

BMO Dividend : 13.07
RBC Dividend : 12.66
Iunits TSX 60 : 12.35

Even with Nortel, after tax the returns are almost identical. Remove the Nortel effect, and XIU stomps the other two.

Are you sure you can predict the next Nortel?

[tidal]

An anecdote about Steve and Dr Bill. I met them both at a Vanguard Diehards "reunion" in Chicago a few years ago

Bylo, you're slipping. Speaking of Diehards , note position #98... you're slipping!

[Shakespeare]

you're slipping!

But he's well in the lead at FWF.

[oldguy]

Are you sure you can predict the next Nortel?

The Nortel effect is probably a once-in-a-lifetime type of thing.

However it can happen again with asset classes as it is happening now with Energy and Materials.

How sure are we that '' Energy and Materials '' prices and demand will remain as high.

This is no longer a matter of fund comparisons , this is a matter of world economics and this is where I believe that a fund manager may have an edge over an index fund by buying or reducing assets as he reads the economy. This is what I mean by better protection in bad times.

[Bylo Selhi]

If you think there will be another Nortel, go active.

And that isn't even an indication of active management skill. Actively-managed funds are prevented by securities regulations to hold more than 10% of their assets in a single security. Index funds had to get a special exemption from that restriction. D'ya think that if actively-managed funds had also been able to get that exemption, many of their "skilled" managers would have loaded up on Nortel in order to [s]compete[/s]keep up with the index during the late '90s tech bull?

[Bylo Selhi]

Bylo, you're slipping. Speaking of Diehards , note position #98... you're slipping!

I know. It's sooo hard to keep posting regularly on M* and also maintain the lead on FWF

[oldguy]

And that isn't even an indication of active management skill. Actively-managed funds are prevented by securities regulations to hold more than 10% of their assets in a single security. Index funds had to get a special exemption from that restriction. D'ya think that if actively-managed funds had also been able to get that exemption, many of their "skilled" managers would have loaded up on Nortel in order to [s]compete[/s]keep up with the index during the late '90s tech bull?

Good point . I didn't know about that.

[YogiBear]

And that isn't even an indication of active management skill. Actively-managed funds are prevented by securities regulations to hold more than 10% of their assets in a single security. Index funds had to get a special exemption from that restriction. D'ya think that if actively-managed funds had also been able to get that exemption, many of their "skilled" managers would have loaded up on Nortel in order to [s]compete[/s]keep up with the index during the late '90s tech bull?

Good point . I didn't know about that.

That is exactly the point- and exactly why any Canadian active equity/ index fund comparison that includes that era is inherently suspect- unless one can show that the Nortel effect had no impact.

Now that you understand why I dismissed your dividend fund/ XIU comparison upthread- and seem to agree that it is not tenable- you now choose to rely upon [s]tactical asset allocation[/s] market timing based upon economic fundamentals as the active management approach upon which you will hang your hat:

[1] However it can happen again with asset classes as it is happening now with Energy and Materials.

[2] How sure are we that '' Energy and Materials '' prices and demand will remain as high.

[3] This is no longer a matter of fund comparisons , [4] this is a matter of world economics and this is where I believe that a fund manager may have an edge over an index fund by buying or reducing assets as he reads the economy. [5] This is what I mean by better protection in bad times.

[emphasis and numbers added]

1. If you mean that a particular sector now, such as Energy, can get as frothy as Nortel- or the entire tech sector- did in 1999, I agree;
   
2. No one can know for sure what will happen to prices and demand- and if they do, they certainly aren't going to tell you or me ...
   
3. Good- so we agree that fund comparisons are done!
   
4. Market timing. Do you have any evidence at all that this sort of activity- even gussied up as "tactical asset allocation"- actually creates value, after expenses, in a consistent enough way to be worth using? I've never heard of any. It's a great strategy to fill an hour as guest "expert" on ROBTV, but as for making money with, it's just putting lipstick on a pig- still stays the same old pig ...
   
5. Financial astrology- has as much relation to [s]"protection"[/s] good portfolio construction as astrology does to the Hubble telescope ...

[Bylo Selhi]

5. Financial astrology- has as much relation to [s]"protection"[/s] good portfolio construction as astrology does to the Hubble telescope ...

"I'd compare stock pickers to astrologers, but I don't want to bad-mouth the astrologers." ...Eugene Fama, the elder.