As ETF Costs Crater, Retirement Investors Win

Posted on February 11, 2013 at 6:02 PM PST by

It can be hard to appreciate the arc of investing history, until you take a sufficiently long view.

Once upon a time, stocks were considered exotic. Most institutional investors placed their trust entirely in bonds, and only then in sovereign bonds.

Backed by national treasuries and an endless supply of future taxpayers, bonds presented the potential for appreciation but, mostly, a reasonably safe income flow. Compounding created growth.

etf costs

It wasn’t until the turn of the past century that buying and owning shares was a “normal” investment practice, and only then in small doses.

The risks were still high, modern corporate reporting still a fantasy. Business owners had every competitive reason to keep their numbers hidden, their strategy opaque.

It was just this kind of opacity that created the dislocations in market prices that made stock investing so lucrative for some. Insider trading rules were vague, and it was easy for a small circle of experts to sell a story and get others to bite.

Fast forward a few decades, and all that has changed. Stock investing these days offers few advantages; the information flow is deep and far more reliable. Certainly, high speed trading has chased out of the market nearly every possible distortion, other than the ones created by traders themselves.

In some ways, we know too much. Stocks have turned, in the words of Vanguard Group Founder Jack Bogle, into “income generators” more than speculative vehicles. When all is said and done, these days stocks are as much about dividends as stock price gains, so-called “total return.”

It’s not surprising, then, that huge numbers of investors have begun to give up on the idea of figuring out which stock will prosper and which will not. As Morningstar reports, the flood into exchange-traded funds (ETFs) has continued unabated.

International ETFs led the pack in the latest round of incoming cash, but that’s in part portfolio allocations moving around. Holdings of U.S. stocks remain high, as do bond positions.

Meanwhile, brokerage Charles Schwab recently announced a platform, called OneSource, through which investors can trade from among 105 ETFs commission-free. In effect, Schwab is repeating a model it built for mutual funds years ago, hoping to attract the hordes of retirement investors who need access to the products at a low cost.

Schwab has a competitor, of course, in TD Ameritrade, which offers a similar number of commission-free funds. All of them are chasing Vanguard Group, which pioneered the cheap fund business and has 46 ETFs that trade without commissions for its investors.

Vanguard also has the advantage of long offering the very cheapest funds in terms of management fees, although Schwab is giving Vanguard a run for its money there, too.

Inefficiencies and ETF costs

Cost matters, a lot. Once you begin to understand how little difference can made in trying to trade on inefficiencies in an efficient market, the costs incurred in the attempt become clear. A small number of insiders could, potentially, still find a way to game a stock in their favor, for a little while.

Most investors, however, just don’t find these kinds of opportunities around, unless they already are close to the stock (and thus legally restricted) or take a chance on little-known shares in far-flung or very small, illiquid markets. Neither strategy is advisable, least of all for retirement investors.

The rest of us should stick to our knitting, and that means owning a balanced allocation of asset classes and keeping costs down.