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One of the biggest criticisms that ordinary investors have about the financial markets is that even when their portfolios are plunging in value, Wall Street firms seem to get rich no matter what happens. That's one of the main reasons that so many investors have stayed on the sidelines even as the stock market has soared from its 2009 lows.
Lately, though, there's been a movement to change Wall Street's heads-I-win, tails-you-lose mentality. Through the quickly growing exchange-traded fund industry, even big money managers are getting the message loud and clear: Low costs are a key element of a successful investment.
ETFs, fees, and you
For several years now, there's been a big price war among brokerage companies and ETF managers over costs. Schwab (NYSE: SCHW ) was the first online broker to offer commission-free ETF trading. Over the next couple of years, many of Schwab's competitors joined in, with one of the most recent being E*TRADE Financial (Nasdaq: ETFC ) and its adoption of various WisdomTree funds for no-commission trades.
Meanwhile, a separate war was going on among ETF managers. With its own line of proprietary ETFs, Schwab set out to challenge Vanguard and its traditional price dominance. Meanwhile, seeing threats from further down the price chain, top ETF providers BlackRock (NYSE: BLK ) and State Street (NYSE: STT ) did fee cuts on many of their respective products.
When low fees are not enough
Of course, in choosing an ETF, a low fee isn't the only thing you should look at. It's at least as important to be comfortable with the investments that a given ETF owns, and to pick ETFs that are focused on areas of the financial markets that you think have the most promise.
For instance, if you're comfortable with a fund that tracks the S&P 500, then there's no reason to pay anything more than the bare minimum fees you can find. As long as a particular ETF has a track record of being able to match the returns of the benchmark it's tracking, paying more just doesn't make sense. That's a large part of how Vanguard beat out iShares in the emerging-market stock space, with Vanguard's ETF passing up the iShares ETF in terms of total assets under management. With fees of less than a third what BlackRock charged, Vanguard captured an important ETF segment from the industry leader.
But beyond substantially identical pairs of ETFs, you can run into apples-to-oranges comparisons that aren't entirely fair. For instance, two funds might purport to be focused on emerging markets but target a different segment of those markets. In those cases, relative performance can be misleading, as the underlying investments each fund holds will provide different returns.
In addition, the rapid growth in ETFs is leading to innovation in the industry. The recent release of the Pimco Total Return ETF (NYSE: TRXT ) , based on its highly successful bond mutual fund of the same name, has gained a lot of attention. Higher fees that come with active management could usher in a new wave of more costly ETFs vying with passive index ETFs for assets.
As the active ETF market evolves, you can bet on some ETFs beating their indexes soundly. But overall, performance of active mutual funds on the whole has lagged behind index funds, and there's little reason to think that active ETF managers will necessarily do any better. Just as with mutual funds, paying higher fees for active ETFs may well turn out to be counterproductive more often than not.
It's your money
In the end, it all comes down to one simple fact: Any money that goes to a broker or ETF manager is money that's coming out of your pocket. Having worked so hard to save that money in the first place, isn't it worth doing what you can to make sure it stays in your hands?
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